For a brief while Wednesday, it looked like the U.S. Federal Reserve might have shown financial markets a glimmer of light at the end of its cavernous rate-hiking tunnel.
Then Fed chair Jerome Powell started talking.
Sure, the U.S. central bank had just raised its benchmark federal funds rate target range by another 0.75 percentage points, to 3.75 per cent to 4 per cent. And yes, it made crystal clear that it expects to raise rates further. But some new language inserted into its rate statement – saying that future decisions would consider the cumulative and lagging impact of the Fed’s steep rate increases this year – was interpreted as a hint that the Fed might be ready to slow the breakneck speed of its hikes and maybe, just maybe, stop raising rates sooner than expected.
By the time Mr. Powell was several minutes into his postannouncement news conference, he had poured buckets of cold water onto that perception.
“It is very premature, in my view, to think about or be talking about pausing our rate hikes,” he said.
“At some point … it will become appropriate to slow the pace of increases, as we approach the level of interest rates that will be sufficiently restrictive to bring inflation down to our 2-per-cent goal,” he said. “We still have some ways to go. And incoming data since our last meeting suggest that the ultimate level of interest rates will be higher than previously expected.”
About the best the Fed chair could offer was that how fast rates should climb – after four straight 0.75-percentage-point leaps, triple the typical scale of individual rate moves – is becoming a secondary consideration to how high they must climb (which, again, is higher than it thought just six weeks ago). And that, by extension, the Fed might soon (but not yet) start talking about whether it should slow the pace, which is a far cry from stopping.
If you held out hope that the Fed was ready to start winding down its hawkish rhetoric, let alone its rate hikes, it most definitely is not.
By the end of the day, the financial markets were still pricing in pretty much the scenario they forecast before this rate decision: at least another 0.5-percentage-point increase in December, and the federal funds rate peaking at 5 per cent to 5.25 per cent in the second quarter of next year. That would represent an increase of five full percentage points in a little over a year.
The relentlessly hawkish tone that Mr. Powell has embraced will keep U.S. rate expectations high and, by extension, provide additional fuel for the already extremely strong U.S. dollar. It complicates matters for other central banks, which will have to decide how closely they need to keep their own rate policy in line with the Fed’s direction as they try to stickhandle through their own inflation worries – with currency pressures now a notable part of the mix.
That includes the Bank of Canada – whose own policy direction looks considerably out of sync with its U.S. neighbour after the past week.
The Canadian central bank scaled back its own rate hike to 0.5 percentage points from 0.75, and governor Tiff Macklem mused about even smaller increases to come. He even discussed approaching the finish line on rate increases, saying, “We’re close, but we’re not there yet.”
As a result, the markets now expect the Bank of Canada’s overnight rate to top out at 4.25 per cent early next year, suggesting two modest 0.25-percentage-point increases – in December and again in late January – before the bank calls it quits.
That paints a scenario where the Bank of Canada would be on the sidelines for several months while the Fed is still raising rates, and Canada’s policy rate would cap out roughly a full percentage point below the U.S. In a highly sensitive period for interest rates, inflation and growth, that would be a pretty gaping policy gulf.
Though it certainly wouldn’t be unprecedented, even in a period of high economic stresses. For instance, for nearly five years during the recovery from the Global Financial Crisis, the Bank of Canada’s key rate was nearly a full percentage point above the Federal Reserve’s funds rate. That divergence could be well justified by the considerably healthier conditions that the Canadian economy and financial system enjoyed at the time.
The fact that Canada’s inflation rate is lower than that of the United States and has gone into decline earlier, and that the Bank of Canada began tightening earlier than the Fed did, may support the case for Canada to end its hiking phase earlier and lower than the Fed.
Still, the impact of rising Fed rate expectations on the U.S. currency does complicate the question. Mr. Macklem himself has acknowledged that a weaker Canadian dollar relative to its U.S. counterpart raises prices for imported goods, a factor that could make the bank’s inflation battle harder.
Nevertheless, Mr. Macklem looks willing to pursue a separate course from Mr. Powell – even if it does make his job more complicated.
“I’m going to let the Fed take their own decisions. We’ve taken ours,” he said at a news conference after last week’s Bank of Canada rate decision. “One of the values of having an independent monetary policy, with a flexible exchange rate, is that we can run monetary policy for the needs of Canada and the needs of Canadians. And that’s what we’re doing.”