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Fed jacks rates again, Powell vows no surrender in inflation battle

Summary

Fed raises policy rate to 2.25%-2.50% range
U.S. central bank flags weakening economic data
Fed’s Powell says failure to tame inflation is not an option

The Federal Reserve said on Wednesday it would not flinch in its
battle against the most intense breakout of inflation in the United
States since the 1980s even if that means a “sustained period” of
economic weakness and a slowing jobs market.

As he explained the logic behind the stiffest interest rate increases
in roughly four decades, Fed Chair Jerome Powell was peppered with
questions about whether the U.S. economy was in or on the cusp of a
recession – a notion he rejected because U.S. firms continue to hire
in excess of 350,000 additional workers each month.

“I do not think the U.S. is currently in a recession,” he told
reporters after the end of the U.S. central bank’s latest policy
meeting, citing an unemployment rate that is still near a half-century
low and solid wage growth and job gains. “It doesn’t make sense that
the U.S. would be in recession.”

But the 75-basis-point rate increase announced by the Fed on
Wednesday, coupled with earlier actions in March, May, and June, has
now jacked the central bank’s overnight interest rate from near zero
to a level between 2.25% and 2.50%. That is the fastest tightening of
monetary policy since former Fed Chair Paul Volcker battled
double-digit inflation in the 1980s.

The cure then involved back-to-back recessions.

Consumer prices haven’t yet breached the 10% annual mark this time –
but at 9.1% they are close enough to raise the stakes for both the Fed
and the Biden administration, which is particularly sensitive on the
issue ahead of congressional elections in November.

While Powell said he did not think a recession would be needed to fix
the problem this time, he acknowledged that the economy was slowing
and would likely need to slow more for the Fed to bring the pace of
price increases back to earth.

“We do want to see demand running below potential for a sustained
period to create slack” in the economy, Powell said in a news
conference. “We’re trying to do just the right amount. We’re not
trying to have a recession.”

But he was adamant that the behavior of inflation would drive the
Fed’s course, and that “another unusually large (rate) increase could
be appropriate” when the Fed next meets if inflation does not begin to
slow.

Powell, and many of his Fed colleagues, have been caught out this year
making policy commitments based on data – particularly on inflation –
that has surprised them in negative ways and forced them to adjust on
the fly.

The Fed chief offered little specific guidance about what to expect
next, a fact that puts a heavy focus on two months of upcoming data.
The Fed’s usual six-week interlude between policy meetings is eight
weeks this time, providing what Powell called “quite a lot of data” to
digest, including July and August inflation readings that will either
show evidence of slowing price increases – or not.

“Restoring price stability is just something we have got to do,”
Powell said. “There isn’t an option to fail.”

When measured by the Fed’s preferred gauge, inflation is running at
more than three times the central bank’s 2% target.

Fed officials are “acutely aware” of the hardship that inflation
imposes on American households, particularly for those with limited
means, Powell said, and they will not relent in their effort until
presented with “compelling evidence” that inflation is coming down.

While jobs gains have remained “robust,” officials noted in the new
policy statement that “recent indicators of spending and production
have softened,” a nod to the fact that the aggressive rate hikes they
have put in place since March are beginning to bite.

DATA-DEPENDENT

New data due to be released on Friday will show to what extent growth
slowed in the second quarter.

Powell said some of the impact of Fed rate increases to date is still
building in the economy, and depending on how inflation responds in
the coming months that could allow the central bank to begin to slow
the pace of rate increases.

The policy rate is now at the level most Fed officials feel has a
neutral economic impact, in effect marking the end of pandemic-era
efforts to encourage household and business spending with cheap money.
The rate also matches the high point of the central bank’s previous
tightening cycle from late 2015 to late 2018, a level reached this
time in the span of just four months.

Investors expect the Fed to raise its policy rate by at least half a
percentage point at its Sept. 20-21 meeting.

“While another unusually large increase could be appropriate at our
next meeting, that is a decision that will depend on the data we get
between now and then,” Powell said. “We will continue to make our
decisions meeting by meeting, and communicate our thinking as clearly
as possible.”

Futures markets tied to Fed policy expectations tilted somewhat back
toward a more moderate increase for the next meeting as Powell spoke
on Wednesday.

In the U.S. Treasury market, which plays a key role in the
transmission of Fed policy decisions into the real economy, yields on
the 2-year note moved lower. The yield on the 10-year note was little
changed.

Stocks on Wall Street added to broad gains in the session, with the
S&P 500 index (.SPX) closing 2.6% higher, while the dollar (.DXY)
weakened against a basket of major trading partners’ currencies.

“From here, it is possible that the Fed slows its tightening pace,
reassured by the likely peaking of inflation and pullback in inflation
expectations as oil prices have fallen,” Seema Shah, chief global
strategist at Principal Global Investors, said in a note. “However,
with the labor market still a picture of strength, wage growth still
uncomfortably high, and core inflation set to decline at a glacially
slow pace, the Fed certainly cannot stop tightening, nor can it
downshift gears too much.”

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