Jay Powell had always said that if inflation was in danger of spiralling out of control, the Federal Reserve would be willing to bring out the hammer to knock prices down.
On Wednesday, in his most hawkish press conference since the start of the pandemic, the chair of the Fed gave the clearest signal yet that such a moment was fast approaching.
“Powell essentially said to the markets and the economy, ‘put on your seatbelt, we are getting ready to take off’,” said Nathan Sheets, global chief economist at Citigroup and a former under-secretary at the US Treasury. “If inflation doesn’t fall as they expect, the Fed is prepared to be vigorous.”
The Fed’s drive towards tighter policy was apparent not just from what Powell said about the path forward for monetary policy, but also what he refused to divulge about the US central bank’s plans for interest rates later this year.
“Powell was distinctly not willing to rule out more frequent [or] larger rate hikes,” Sheets said.
Powell made clear that the first increase to the main policy rate since 2018 was all but certain to be implemented at the next meeting in March. But he was opaque about what would happen after that point and left the door open to much more forceful action to cool the US economy.
Despite being given multiple opportunities to reiterate the Federal Open Market Committee’s preference for a “gradual” approach to raising rates — which he spoke of as recently as last month’s meeting — Powell repeatedly dodged questions about the central bank’s thinking now that inflation appears to be persistent.
In place of “gradual” was another watchword, “nimble”, which traders interpreted as a newfound willingness to entertain a much more aggressive tightening cycle.
When asked whether the Fed would consider raising interest rates at each subsequent policy meeting this year, which would result in seven increases in 2022, he simply said no decision had yet been made.
He also declined to rule out the possibility that the Fed would raise rates by half a percentage point at one of its forthcoming meetings, double its typical quarter-point cadence. The central bank has not implemented a 0.5 per cent increase for more than two decades.
US stock markets balked at the Fed chair’s hawkish stance. The sell-off in the S&P 500 ranked among the worst performances for the benchmark stock index during a post-meeting press conference from Powell, according to research firm Bespoke Investment Group.
A 2.2 per cent advance unwound as Powell fielded questions from journalists, with the S&P 500 closing in the red.
Bespoke noted that the only time markets sold off more while Powell was on his feet at a press conference was in December 2018, when the chair unnerved markets as he forged ahead with tighter policy in the middle of then-president Donald Trump’s trade wars.
Ellen Zentner, chief US economist at Morgan Stanley, said that by being “deliberately vague”, Powell was keeping all of the Fed’s policy options open at a time when the economic outlook was historically difficult to assess.
Whether that means “front-loaded” interest rate rises from March or increases spread more evenly over the year is not yet clear, but markets are now primed for a variety of scenarios.
“The boilerplate approach from the Fed is to maintain maximum flexibility,” Zentner said, noting that Powell’s “hawkish colours” showed through on Wednesday. “The economy can throw us for a loop at any given time, so you can’t really message about a path for policy because it is highly uncertain given the outlook itself is highly uncertain.”
Yvette Klevan, a fixed-income portfolio manager at Lazard Asset Management, said: “Powell definitely turned the dial up a little bit in terms of conveying a more hawkish narrative.”
She suggested a half-a-percentage point increase in March might be “excessive” but that it was “not totally out of the question” given Powell’s refusal to rule out such a move and the fact that forthcoming data could confirm just how hot the US economy is.
Powell pointed out that the US economy was much stronger than in 2015, when the Fed last embarked on a rate-rising cycle. Back then, the central bank adopted a cautious approach to tightening policy.
But Powell’s remarks on Wednesday drove home the fact that the central bank could move more quickly this time round to bring rates back from near-zero to 2.5 per cent — the level that a majority of officials think will be sufficient to constrain economic activity.
Joe Davis, chief global economist at Vanguard, reckons the policy rate will eventually have to rise to 3 per cent — well above market expectations — to damp demand.
Powell’s argument that there was “quite a bit of room to raise interest rates without threatening the labour market” further cemented expectations of a more aggressive approach. So did his remark that he believed the US had reached full employment.
Analysts at Deutsche Bank now see five interest rate increases this year, with the first three occurring by the June meeting. They forecast the Fed will begin shrinking its almost $9tn balance sheet in July, with additional details about the speed of that effort being unveiled in May.
Powell seemed unfazed when asked about the impact of the Fed’s newfound hawkishness on US markets, which have whipsawed this year as traders position themselves for higher rates.
“Financial conditions are reflecting in advance the decisions that we make,” he said. “Monetary policy works significantly through expectations.”
For Michael Feroli, the top Fed watcher at JPMorgan, Powell’s new approach could be summed up like this: “No more Mr Nice Guy.”
Additional reporting by Eric Platt in New York