MNI FED WATCH: Credit Tightening Caps FOMC's Terminal Rate

Recent U.S. banking system turmoil will likely tighten credit conditions and help control inflation without much higher interest rates, Federal Reserve Chair Jerome Powell said Wednesday.

The severity and extent of the credit tightening is unknown but "it's potentially quite real," Powell told reporters after the FOMC voted to raise interest rates another quarter point to a 4.75%-5% range and signaled one more hike this year. "That argues for being alert as we go forward as we think about further rate hikes. We'll be paying attention to the actual and expected effects from that."

A "significant number" of Fed officials are anticipating a pullback in lending, he added, "and that would really have the same effects as our policies do."

If that turns out not to be the case, Powell said, "in principle, you'd need more rate hikes. So some people did reflect that in their SEP forecast."

BUMPY INFLATION SLOWDOWN

Inflation remains too high and data since February point to stronger inflationary pressures than earlier thought, Powell said.

There was some discussion of pausing rate hikes but “rate cuts are not in our base case,” Powell said.

Officials raised forecasts slightly for headline and core inflation, now expecting them to end the year at 3.3% and 3.6%, respectively. Headline inflation is expected to fade to 2.5% by the end of 2024. Headline and core PCE inflation were 5.4% and 4.7%, respectively, in January.

Goods inflation is falling even if at a rate more slowly the Fed would like to see, while it's "only a matter of time" before housing inflation falls, Powell said. There's little progress yet in non-housing services but that should come with softening demand and some labor market weakening, he added.

The disinflation story is "intact," he said. But, "the process of getting inflation back down to 2% has a long way to go and is likely to be bumpy."

STILL SEEKING SOFT LANDING

Emergency Fed lending has bolstered confidence in the banking system and forestalled "what might otherwise have been an abrupt and outsized tightening in financial conditions," Powell said.

Temporary expansion of the Fed's balance sheet is intended to meet the extraordinary liquidity demands of banks facing massive deposit withdraws and not to alter the stance of monetary policy, and no changes to QT have been discussed, he said.

Financial conditions have probably tightened "more than the traditional indexes say," especially considering lending conditions in addition to movements in rates and equities, he added. "You can think of it as being the equivalent of a rate hike, or perhaps more than that. Of course, it's not possible to make that assessment today with any precision whatsoever."

The question for the FOMC is how long the turmoil continues, he said. "The longer it's sustained, then the greater will be the likely tightening in credit standards and credit availability."

A pathway to a soft landing still exists, he said. "We're certainly trying to find it," Powell said in response to a question from MNI at the press conference.