Governor Speak: Jerome Powell on interest rate trajectory

6 Feb 2024 , 07:45 AM

POWELL REFUSES TO GIVE RATE CUT GUIDANCE

Just 4 days after Jerome Powell read out the Fed policy statement on January 31, 2024 and took questions; it is the Fed speak that is assuming a lot of importance. After the December Fed policy had hinted at 75 bps of rate cuts in 2024 and 100 bps in 2025, the next big question was, when? In the minutes of the December 2023 Fed meet and in the January Fed statement, the markets were expecting some hints as to the trajectory of when rate cuts would begin and the course it would take. However, that has not been forthcoming. Between the January Policy and the next policy statement in March 2024, the markets will be largely relying on market statements by the Fed governors and the Fed chair to gauge the direction and trajectory of interest rates.

In his post-policy 60-minute interview with CBS, Jerome Powell spelt out what the Fed intended to do, the factors impacting their decision and how the Fed would deal with incoming data. Powell has continued to maintain that inflation would be central to the Fed equations and everything would revolve around price stability. The only other question that the Fed would address would be whether their decision was impacting full employment. The Fed Chair, like in his post-policy statement, reiterated that growth considerations would not be a part of the factors that the Fed would give too much importance to, when it comes to setting the interest rate cut agenda.

KEY TAKEAWAYS FROM THE JEROME POWELL CBS INTERVIEW

In his 60 minute interview with CBS, Powell made some interesting comments about the rates trajectory and the factors that would trigger the decision.

1. According to Powell, “With the US economy strong, the Fed members fell they have the luxury to approach rate cut timing question carefully.” Powell is on the mark. The Q4 GDP was estimated at 2.2% and the first advance estimate has come in at 3.3%. Now the Atlanta Fed has pegged the Q1 expected growth of the US economy at 4.2%, against the street expectation of 3%. Clearly, it is not just the GDP growth that is robust, but even the jobs situation is very robust with unemployment refusing to go meaningfully above the 3.7% even in the latest week. The message appears to be that the confidence level is definitely rising in the US economy, but the Fed would wait for more confidence before giving the green signal to commence rate cuts.

    

2. In his interview, Jerome Powell underlined that “The US economy was making good progress on inflation.” Obviously, he was referring to the PCE (personal consumption expenditure) based inflation that is normally announced in the last week of the month. For the months of November and December 2023, the PCE headline inflation has stayed static at 2.6%. However, the good news is that core inflation and food inflation continue to fall. That means; but for the impact of the Red Sea crisis, the inflation in the US is actually falling. However, Powell did warn that if inflation continue to remain persistent in the coming months, then the Fed retains the option to hike rates later.

    

3. There were some positive vibes in the interview. Powell did admit that “The Fed could move sooner on rate cuts if they saw labour market weakness or inflation come down persuasively.” The key word here is Persuasively. That means; like GDP growth has surprised on the upside, the inflation needs to surprise the Fed on the downside. Amidst the Red Sea crisis, that looks like a rather rich idea. However, Fed has underlined that it was hard for him to give discrete answers in black or white as a lot would depend on multiple-regression variables.

    

4. Like in the policy statement, the Fed Chair reiterated his standard position that “The March 2024 Fed meeting would likely be too soon to have confidence to start rate cuts.” However, there is one thing that the markets can hope for. March is also when the quarterly projections of inflation, GDP growth and the labour market will be updated for the next 4 years. The last quarterly update in December 2023 hinted at a likely median Fed rate of 4.6% by December 2024. That is about 75 bps down from the current levels and gels with what the Fed has stated in its policy statement. For now, it looks like Powell is broadly in consonance with this point of view.

    

5. Commenting on his expectations of inflation trajectory for the coming year, Powell has been categorical that, “ The Fed expects inflation will continue to move down in the first six months of 2024, largely due to base effects.” In addition, the Fed also expects that the yearly 12-month inflation reading would also fall during the course of the year. That is a rolling number and is a more smoothened approach to inflation, ignoring the short term fluctuations. However, this expectation is under Ceteris Paribus conditions that there would be no major geopolitical or supply chain disruption that could result in an inflation surge. That is something that is, anyways, hard to predict at this point of time.

    

6. Speaking on the much dreaded Recession word, Powell has affirmed that, “The Fed did not see any elevated possibility of a recession.” However, Powell has been quick to clarify that while a recession would have been a concern for the Fed, that is not the case any longer. Recent data flows on GDP and labour market indicate that the US economy may have already made a soft landing, although it is normally tough to confirm such things. Ini the same breadth, Powell has also clarified that GDP growth will not be a factor that would influence the Fed rate decision in the coming months. That means; the argument that the Fed should cut rates to boost GDP growth or the argument that Fed should tighten dur to stable GDP growth, does not hold too much water for the FOMC.

    

7. When it comes to any interview with the Fed Chair, one logical question is about the timing of the rate hikes from March 2022 onwards. Powell has been quick to admit that the Fed may have delayed in commencing the rate hike program. The Fed genuinely felt that it would have been a better choice to start hiking rates, probably, from the last quarter of 2021, rather than waiting till March 2022 for the first rate hike. Apparently, the Fed had underestimated the ferocity and stickiness of inflation from 2021 onwards. There were signs of inflation picking up from early 2021 onwards, but the Fed had continued to hold that the inflation spike was ephemeral. However, demand growth was faster than expected and the supply chains were constrained more than imagined. However, in policy making, it has to be forward looking and it adds little value to be prophets of the past.

    

8. On the 2 macro challenges of commercial real estate loans and China growth, Powell is affirmative that the impact would be negligible. On the subject of commercial real estate loans, Powell has underlined that while there is some stress, there is no major problem that could impact banks in any way. He was reacting to suggestions that we could see a benign repeat of the sub-prime crisis. However, Powell has ruled out such possibilities. Even on the China issue, he believes that considering its size, there would be a global impact. However, the US economy is still predominantly driven by domestic consumption and hence the direct impact of any problems faced by China will be minimal as far as the US economy was concerned.

    

9. Finally, what is the one big risk that Powell sees to the US economy in particular and the global economy in general. According to Powell, “Geopolitical risks stand as largest near-term risks, but more for other parts of the world than for the US.” In a sense, he is right. The US is already the largest producer of oil and most of its imports are not dependent on the Suez Canal route. Also, the principal trade routes for their major partners like Europe and Asia either use the Atlantic route or the Pacific route. Both do not have to rely on the Suez Canal route. In short, the trade impact would be limited, although the impact on commodity prices would still be there.

To sum it up, Powell is clear that rate cuts may happen only from May or June onwards. However, he still believes that the Fed has a base case for 3 rate cuts in 2024 and 4 rate cuts in 2025. That is assuming that the macros do not surprise, either ways. The big advantage that the US has is that the economy looks to be in fine fettle!