Jackson Hole, August 25, 2023— The continued strength of the U.S. economy could require further interest rate increases, Federal Reserve Chair Jerome Powell said Friday in a closely watched speech that also highlighted the uncertain nature of the economic outlook.
Powell noted that the economy has been growing faster than expected and that consumers have kept spending briskly — trends that could keep inflation pressures high. He reiterated the Fed’s determination to keep its benchmark rate elevated until inflation is reduced to its 2% target.
“We are attentive to signs that the economy may not be cooling as expected,” Powell said. “We are prepared to raise rates further if appropriate and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”
“Although inflation has moved down from its peak — a welcome development — it remains too high.”
Powell’s speech, at an annual conference of central bankers in Jackson Hole, Wyoming, highlighted the uncertainties surrounding the economy and the complexity of the Fed’s response to it. It marked a contrast to his remarks here a year ago, when he bluntly warned that the Fed would continue its campaign of sharp rate hikes to rein in spiking prices.
“When it comes to another rate hike, the chair still very much has his finger on the trigger, even if it’s a bit less itchy than it was last year,” said Omair Sharif, chief economist at Inflation Insights.
Substantially higher loan rates, a direct result of the Fed’s rate hikes, have made it harder for Americans to afford a home or a car or for businesses to finance expansions. At the same time, items like rent, restaurant meals and other services are still getting costlier. “Core” inflation, which excludes volatile food and energy prices, has remained elevated despite the Fed’s streak of 11 rate hikes beginning in March 2022.
The overall economy has nevertheless powered ahead. Hiring has remained healthy, confounding economists who had forecast that the spike in rates would cause widespread layoffs and a recession. Consumer spending keeps growing at a healthy rate. And the U.S. unemployment rate stands exactly where it did when Powell spoke last year: 3.5%, barely above a half-century low.
“He is still very concerned how rapid the economy is growing because that does actually mean, all else equal, we need higher interest rates just to be restrictive,” said Diane Swonk, chief economist at KPMG.
In his speech, Powell did not mention the possibility that the Fed will eventually cut interest rates. Earlier this year, many on Wall Street had expected rate cuts by early next year. Now, most traders envision no interest rate cuts before mid-2024 at the earliest.
Powell said the central bank’s policymakers believe their key rate is high enough to restrain the economy and cool growth, hiring and inflation. But he acknowledged that it’s hard to know how high borrowing costs must be to slow the economy, “and thus there is always uncertainty” about how effectively the Fed’s policies are in reducing inflation.
The Fed’s officials “will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data,” he said.
Since Powell spoke at last summer’s Jackson Hole conference, the Fed has raised its benchmark rate to a 22-year high of 5.4%. From a peak of 9.1% in June 2022, inflation has slowed to 3.2%, though still above the Fed’s 2% target.
Powell acknowledged the decline in inflation, which he called “very good news.” Consumer prices, excluding the volatile food and energy categories, have begun to ease.
“But two months of good data,” he added, “are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal.”
In June, when the Fed’s 18 policymakers last issued their quarterly projections, they predicted that they would raise rates once more this year. That expectation might have changed, though, in light of milder inflation readings the government has issued in recent weeks. The officials will update their interest rate projections when they next meet Sept. 19-20.
Some Fed officials, including John Williams, president of the Federal Reserve Bank of New York, a top official on the interest-rate setting committee, have suggested that the central bank may be nearing the end of its rate hikes.
Many economists have postponed or reversed their earlier forecasts for a U.S. recession. Optimism that the Fed will pull off a difficult “soft landing” — in which it would manage to reduce inflation to its target level without causing a steep recession — has risen.
Many traders in the financial markets envision not only a soft landing but an acceleration of growth. Those expectations have helped fuel a surge in bond yields, notably for the 10-year Treasury note, which heavily influences long-term mortgage rates. Accordingly, the average fixed rate on a 30-year mortgage has reached 7.23%, the highest level in 22 years. Auto loans and credit card rates have also shot higher and could weaken borrowing and consumer spending, the lifeblood of the economy.
Emily Roland, co-chief investment strategist at John Hancock Investment Management, is among the analysts who still doubt that the Fed will achieve a soft landing.
“The lag impact of all the tightening that the Fed has done — the most amount that we’ve seen in decades — is likely to bite and tip the economy into a recession,” she said. “It’s just taking a while to get there.’’
Likewise, Sonia Meskin, head of U.S. macro at BNY Mellon Investment Management, said she worries that the financial markets are “underestimating the chances of a harder, delayed landing.’’
“Much of the tightening might still be in the pipeline,’’ Meskin said, and the full impact of higher rates might not hit until next year.
Some economists say they think that much higher long-term rates in the bond market might lessen the need for further Fed hikes because by slowing growth, those long-term rates should help cool inflation pressures. Indeed, many economists say they think the Fed’s July rate increase will prove to be its last.
Even if the Fed imposes no further hikes, it may still feel compelled to keep its benchmark rate elevated well into future to try to contain inflation. This would introduce a new threat: Keeping interest rates at high levels indefinitely would risk weakening the economy so much as to trigger a downturn. It could also endanger many banks by reducing the value of bonds they own — a dynamic that helped cause the collapse of Silicon Valley Bank and two other large lenders last spring. – AP
