Powell Tunes Out Washington Clamor, Sticks to Quarter-Point Plan

(Bloomberg) -- Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.

Jerome Powell is trying to balance uncertainty over the Ukraine war with political demands back home to move faster on inflation. That's a hard policy act to pull off without something breaking.

Over two days of congressional hearings that wrapped Thursday, the Federal Reserve chair heard dismay from lawmakers in both parties over the fastest rate of inflation in 40 years, and urgent calls to do something about it.

Powell said he would -- starting with a quarter-point increase in interest rates at the central bank's policy meeting on March 15-16. But that effectively takes a bolder half-point move aired by some of his colleagues off the table, just as Russia's invasion of Ukraine sends oil prices surging, which will only make inflation worse.

Such gradualism could come with a cost, said Matthew Luzzetti, chief U.S. economist at Deutsche Bank Securities Inc.

“A more cautious initial approach does raise the risk of having to move more aggressively down the road, particularly as near-term inflation pressures will worsen and medium-term inflation risks shift further to the upside,” he said.

Powell must navigate the risk of tightening so quickly that the economy stumbles, while acting with enough vigor to cool surging inflation -- and do it while his ability to look forward has been fogged by a war that's sending financial markets into a spasm.

While gradualism may be strategically correct -- especially when rates are still near zero which leaves no margin for a policy error if the fed goes too fast -- lawmakers want to see action.

In a telling exchange, Alabama Republican Senator Richard Shelby asked Powell if he ignored the inflation data or just missed it as it started to worsen last year.

“Hindsight says we should have moved earlier,” Powell said, offering a rare mea culpa for a Fed chair. “It's just taking so much longer for the supply side to heal than we thought.”

Powell pledged to do whatever it takes to get inflation lower. He and his colleagues will begin to spell what that strategy looks like at their meeting later this month, when they'll have February's reading on consumer prices in hand. Economists surveyed by Bloomberg see yearly CPI rising 7.9%.

The Fed will publish its latest forecasts for interest rates and the economy on March 16. Officials have already pivoted toward more aggressive policy action as jobs and inflation numbers have heated up in recent weeks, rapidly moving away from their call for a relatively modest three rate hikes in 2022 in there December estimates.

If the new projections show inflation easing this year and next, the number of rate increases that Fed officials expect they'll need to make that happen will need to be credible.

That might mean signaling they will hike rates above their estimate of the so-called neutral level -- a theoretical policy setting that neither speeds up or slows down the economy -- currently estimated around 2.5%.

And if they do that, and thereby implicitly cooling demand, it raises the question of whether they will also project an increase in their estimates for the unemployment rate beyond 2022.

Labor Market

Powell repeatedly pointed to the tight U.S. labor market, saying its current condition wasn't consistent with getting inflation back to the Fed's 2% long-term target. At one point, he called it “overheated,” an indication that the inflation fight may require that rates go high enough to slow hiring.

“If the current labor market is not consistent with price stability – that begs the question: then what is?” said Diane Swonk, chief economist at Grant Thornton LLP. “If you want to avoid entrenched inflation given the high prices we have, you are going to have to have higher unemployment.”

With Americans already disgruntled by high prices eroding their purchasing power, it is hard to see how a tougher job search or higher unemployment is going to make them or their lawmakers happier. There is no political optimum for Powell and the Fed right now.

“For Democrats facing voters in 2022, what matters is that the Fed can tighten without throwing the economy into a recession,” said Sarah Binder, a senior fellow at the Brookings Institution. 

“Will gradualism avoid a recession? Or will gradualism leave Biden and the Fed more exposed to criticism that they are not doing enough to stem inflation?” she said. “A recession would not be politically optimal either.”

©2022 Bloomberg L.P.