If there was any question that the Federal Reserve is willing to push the U.S. economy to the edge of recession – or even over it – to defeat inflation, Fed Chair Jerome Powell removed it Wednesday.
Speaking with reporters after the U.S. central bank’s seventh interest-rate increase of 2022, Mr. Powell indicated that he’s prepared to slow the dizzying speed of U.S. interest-rate increases heading into 2023. But he made it clear that he’s not prepared to stop – even as he and his Fed colleagues projected that further rate hikes will bring the U.S. economy to a near-standstill next year.
“We’re not at a sufficiently restrictive policy stance yet, which is why we say that we would expect that ongoing hikes would be appropriate,” Mr. Powell said in his news conference following the rate decision.
“We still have some ways to go,” he said.
The tough-talking news conference was a blast of cold water for anyone who thought that the Fed’s rate announcement – a half-percentage point hike to a range of 4.25 to 4.5 per cent, down from the three-quarter-point increases in the Fed’s previous four decisions – might represent a step toward the end of this rate cycle.
While the four-paragraph official statement accompanying the statement shed remarkably little light on the evolution of the Fed’s thinking (it was virtually a word-for-word duplicate of the previous statement in early November), everything else Mr. Powell and his colleagues said Wednesday underlined that the Fed is nowhere near declaring an end to rate hikes.
The new economic and rate projections accompanying the announcement signalled that the Fed thinks inflation is proving more stubborn than it previously expected, that it expects to raise rates higher than it previously thought – and that U.S. employment and economic growth will suffer as a result.
Fed members now project that rates will peak between 5 per cent and 5.25 per cent next year – or another three-quarters of a percentage point from the current level. They see economic growth in 2023 of a puny 0.5 per cent, placing a recession well within the Fed’s forecast range, as the higher peak for rates exerts more downward pressure on the economy.
About the only relief that Mr. Powell offered was that he is now prepared to go slower on rate hikes than the Fed did in 2022, when it increased its policy rate by 4.25 percentage points in just nine months.
“It’s now not so important how fast we go. It’s far more important to think [about] what is ultimate [peak] level,” he said.
“The appropriate thing to do now is to move to a slower pace. That will allow us to feel our way … and better balance the risks that we face.”
The prospect of a Federal Reserve continuing to nudge already sharply increased borrowing costs still higher through 2023 – albeit in, say, comparative baby steps of a quarter-point at a time – seems little reward for what has been a pretty substantial downturn in U.S. inflation. On Tuesday, the U.S. government reported that the year-over-year inflation rate had fallen to 7.1 per cent in November – down more than a full percentage point in just two months, and down two percentage points from the peak in June. Over the past four months, month-to-month inflation has receded to prepandemic norms.
Mr. Powell says he’s not yet convinced. He says he wants to see more compelling evidence of a “sustained” inflation retreat. And in particular, he says he’s worried about a labour market that is still extremely tight, and the pressures that still implies for wage inflation.
Perhaps. But given the direction of the inflation data, one has to wonder if Mr. Powell and his Fed colleagues aren’t making a conscious choice to maintain a glass-half-empty stance here. They remain concerned about higher inflation expectations becoming ingrained in the public mindset. They don’t love that bond yields have gone into retreat even as they have continued to push the policy interest rate higher, on speculation that falling inflation and a possible recession will force the Fed to start cutting rates sometime next year.
A message of, “Hey, we’re nowhere near done yet” helps reinforce the rate hikes, alter behaviour and, ultimately, make restrictive rate policy more effective. If the markets and public embrace the message, it could, counterintuitively, actually allow the Fed to wind up the hiking cycle sooner than it would have otherwise. Or at least that’s the logic behind such hawkish central bank communications.
But taken at face value – which is the prudent way to take it – the Fed absolutely looks prepared to turn up the heat considerably further on inflation, even at the expense of a recession and a rise in unemployment. It’s a tricky path for the Fed, which operates under a dual mandate of both maintaining price stability and maximizing employment.
Mr. Powell can certainly keep that up for at least one more rate decision (the next is scheduled for Feb. 1) to keep a lid on market expectations while giving the Fed seven more weeks of economic data, including another inflation report. But if U.S. inflation keeps trending lower, one wonders how much beyond that such an unhappy message will be believed, or tolerated.