MNI FED WATCH: Cautious Powell Signals 'Couple' More Fed Hikes

Federal Reserve Chair Jerome Powell on Wednesday signaled the FOMC sees interest rates moving above 5% this year but indicated the central bank is ever more data dependent as it approaches peak rates for the cycle and proceeds to hold them there at least through this year.

The FOMC stepped down again and lifted interest rates by a smaller quarter point to a target range of 4.50%-4.75% Wednesday and Powell said rates are currently restrictive and officials are "talking about a couple more rate hikes to get to the level we think is appropriately restrictive." But investors unwound pricing for a slightly higher terminal rate after Powell's press conference close to 4.90% and priced in almost 50bp of cuts later this year.

"I am not particularly concerned about the divergence," Powell said when asked about fed funds futures pricing. "It is largely due to the market's expectations inflation will move downward quickly."

"Given our outlook, I just don't see us cutting rates this year if our outlook comes true. If we do see inflation coming down much more quickly that will play into our policy-setting," he told reporters.

Still, while Powell presented a more two-sided and data-dependent view of the outlook than many had expected going into the meeting, the Fed chief showed bias towards raising rates higher given the balance of risks.

"I continue to think that it is very difficult to mange the risk of doing too little and finding out in six or twelve months that we actually were close but didn't get the job done, inflation springs back and we have to go back in," he said. "This is a very difficult risk to manage, whereas of course we have no incentive and no desire to overtighten but if we feel like we've gone too far and inflation is coming down faster then we would have tools that would work on that."

"We're going to be cautious about declaring victory," he said. Powell declined to say the Fed's December SEP projections are the central bank's baseline and instead noted officials will submit projections again in March.

EARLY DISINFLATIONARY PROCESS

Powell welcomed recent reports showing moderation in consumer prices but warned some components of inflation may not come down as quickly as goods and housing. PCE inflation rose 5.0% in the year to December, while core prices eased to 4.4%.

"I would also say the inflationary process you see under way is really at an early stage," he said. "I would say, so far what we see is progress, but without weakening in labor market conditions."

"While recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path."

Positive growth will continue but at a subdued pace this year, amid a global outlook that is improving, with a "very, very strong" labor market and positive outlook for consumer sentiment as inflation comes down, he said.

"My base case is that the economy can return to 2% inflation without a really significant downturn or really big increase in unemployment," Powell said. "I think that is a possible outcome." (See MNI INTERVIEW: US Labor Market Could Have Soft Landing-Paychex)