Markets were buoyed by Chairman Jerome Powell’s comments at Wednesday’s press briefing, but we wonder if it wasn’t overkill. Prices rose as if tighter monetary conditions were not going to last long and this is worrying as an anti-inflation message.
The Federal Open Market Committee’s four-paragraph statement after its meeting was hawkish on inflation. “The committee pays close attention to inflation risks,” it said.
But Mr. Powell sounded much less hawkish at several points in his hour-long press. It was particularly noteworthy to hear him say that current interest rates are close to “neutral,” meaning they are no longer accommodative. But even after Wednesday’s 75 basis point hike, the fed funds rate is only 2.25% to 2.5%. The inflation rate was 9.1% in June, which means that real interest rates are still significantly negative.
Mr Powell also said he thought rates might not need to go much further, citing the Fed’s June median forecast of 3.25% to 3.5%. Markets signaled ahead of the meeting that they believe the Fed will start cutting rates in a year’s time. And while Mr. Powell didn’t bless that feeling, he didn’t do much to dispel it either.
Not to be rude, but when the fed funds rate was between 2% and 2.25% in October 2018, Mr Powell said “we are far from neutral” on interest rates. The inflation rate at that time was only 2.5%. Times and circumstances change, but the meaning of “neutral” couldn’t possibly have changed that much.
The Fed chair has insisted more than once that he and his colleagues are committed to bringing inflation back to their 2% target. We hope so. And it seems likely that the annual inflation rate will fall from 9% in the coming months as oil and other commodity prices have fallen. Slowing growth will also contribute to this.
But the lesson of the 1970s is that ending the fight against inflation too soon will result in inflation falling from its highs as the economy slows but still remaining uncomfortably high at a new plateau. It then rises again as the economy recovers and hits new heights. Then do it all over again until the tightening medicine has to be far more stringent than it would have been had the Fed stayed the course earlier.
It’s always a mistake to interpret too much into immediate market moves like Wednesday’s. But if they are right that the Fed is signaling an end to tightening soon, then there is a risk that we are witnessing a false dawn in the fight against inflation.
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Published in the print edition on July 28, 2022.
https://www.wsj.com/articles/investors-love-jerome-powell-federal-reserve-markets-inflation-monetary-tightening-11658959032 Investors Love Jerome Powell – WSJ