Jerome Powell underlines the Fed policy hawkishness

22 Mar 2022 , 12:32 PM

On Monday 21st March, 3 key indicators in the US were strongly influenced by extremely hawkish statements made by Jerome Powell, chairperson of the US Federal Reserve.

• US Bond yields scaled up to 2.34% on hawkish outlook by the Fed chair. This is the highest 10-year bond yield level in the US in the last 38 months.
• The Bloomberg Dollar Index (DXY) touched a level of 98.5, very close to the 52-week high level of 99.4. Higher rates tend to make the dollar stronger.
• The Dow corrected sharply on Monday after the extremely hawkish comments by Jerome Powell as it is still well below the Jan-22 peaks.

Hawkishness was the underlying theme of Jerome Powell

Speaking at the 38th Annual Economic Policy Conference of the National Association for Business Economics, Washington, Jerome Powell reiterated his hawkish outlook for rates. He was addressing the conference on “Policy Options for Sustainable and Inclusive Growth”. The gist of the speech given by Powell was that for the US economy, hawkishness was the best choice at this point of time.

The theme of Powell’s speech was that price stability was the top priority of the US Federal Reserve. That is hardly surprising considering the 7.9% consumer inflation in Feb-22 in the US. Talking on policy options, Powell underlined that his focus would be as much on inclusive growth as on sustainable growth. That is how a more hawkish policy stance fits in. Fed had hiked rates by 25 bps in March and guided for 6 more hikes in 2022.

10 key takeaways from the Jerome Powell speech

If one were to break up the theme of the speech, here are key takeaways that emerge.

1. Powell has underlined that Fed policy stance would continue to be guided by the dual mandate of promoting maximum employment and stable prices. Powell added that since labour market was fairly strong, tackling inflation was the primary focus.
2. Talking of inclusive growth, Powell highlighted that high inflation imposed significant costs on those segments of society least able to bear the burden. With higher inflation in food, housing, clothing and transport, the impact on the vulnerable classes was huge.
3. To explain the Fed stance, Powell has clarified that the first focus would be to quickly return the stance of monetary policy to neutral level. The next step would be to move monetary policy to more restrictive levels if required in the interest of price stability.
4. In the FOMC statement, the hint was of one rate hike in each of the remaining 6 FOMC meetings in 2022. Powell anticipates that the ongoing rate increases would be suitable to reach the objectives of sustained and inclusive growth. In short, the objective of price normalization and stability takes precedence over all other factors for the Fed.
5. On the subject of trimming the $9 trillion balance sheet of the Fed, Powell underlined that the intent was to start unwinding of the book from May but final decision was yet to be taken. He has added a caveat that any decision on balance sheet unwinding would be based on the economic conditions and whether it warranted liquidity rollback.
6. Powell pointed out a specific anomaly of the labour market being strong, yet tight. Unemployment is already at 3.8%, close to pre-pandemic levels. Tight labour markets means that more job openings are going unfilled today compared to pre-pandemic period. There were 1.7 job postings for every person looking for work.
7. What explains this labour market anomaly? Powell proffered several possible reasons. One reason could be that wage pressures are too high across levels. There could, hence, be a degree of fatigue in labour markets. The second reason is that labour force participation rate has not recovered to pre-pandemic levels. It could be due to more comfortable financial situation giving leeway to wait for the right job.
8. Inflation outlook had deteriorated even prior to the Russia Ukraine war. Rise in inflation was sharper, tougher and more persistent than expected. While Powell is confident that it is still the supply chain disruptions causing inflation, he has also veered around to the view that high inflation could be a norm for a much longer period. According to Powell, this inflation is an outcome of severe and persistent supply-side frictions combined with robust demand for durable goods, which produced surprisingly steep inflation.
9. Powell added that the Russia Ukraine war had added a new dimension to inflation as disruption of oil supply had the potential to cause primary, intermediate and secondary inflation. Oil has been one of the major driving factors of inflation in the last 6 months.
10. Finally, Powell added that the pandemic and its aftermath had tested traditional macroeconomic assumptions like never before. The normal expected path was that supply side damage would cool, demand would stabilize, output would grow and inflation would come under control. However, that did not happen and hence it has forced the Fed into an affirmative policy response.

How Fed policy response is being calibrated

According to Powell, the current situation called upon the Fed to be affirmative about tightening despite the global geopolitical risk. Based on dot plot charts, median interest rate projection is of 1.9% by end of 2022 (compared to 0.25%-0.50% currently). In short, the Fed has pencilled total 6 rate hikes across the remaining 6 FOMC meetings in 2022. Powell believes that only by combining rate hikes with balance sheet unwinding; Fed can achieve the target of 2% inflation over next 3 years.

An important aspect is whether the Russia Ukraine war would impact future Fed policy path? Powell did express apprehension that amidst rising commodity inflation, the Russia Ukraine war had the potential to derail economic growth. Powell also added that spill-overs, including to the US economy, cannot be ruled out. However, being an exceptional situation, the Fed would address this risk as it evolved.

Finally, the most important assumption for the Fed would be that monetary policy can lower inflation without causing a debilitating recession. Some growth moderation would happen as the base effect vanished. However, previous experiences testify that rising rates hardly causes a recession. As Powell best summed it up, “Monetary policy is a blunt instrument, incapable of surgical precision”. Therein, perhaps, lies the biggest risk for the Fed and for the world economy.