MNI FED WATCH: Powell Promises Tighter Policy, Held For Longer

Federal Reserve Chair Jerome Powell on Wednesday sought to convince investors interest rates are headed above 5% in 2023 and will stay there until high inflation is tamed, although market expectations remained stubbornly more dovish, counting on a lower terminal rate and cuts next year.

The FOMC lifted interest rates by another half percentage point to a target range of 4.25%-4.5% Wednesday and penciled in another 75 bps of increases next year. But investors continued to price in a terminal rate close to 4.85%, little changed by the projections and Powell's words, with two quarter-point cuts by December 2023.

"We're not at a sufficiently restrictive policy stance yet, which is why we say that we'd expect that ongoing hikes will be appropriate," Powell told reporters. "Overwhelmingly FOMC participants believe that inflation risks are to the upside, so I can't tell you confidently that we won't move up our estimate of the peak rate again at the next SEP." (See MNI INTERVIEW: Fed Must Hike to 6-8% For 'Restrictive'-Lacker)

Whether the next rate hike on February 1 will step down again to 25 bps is "not so important" and has not yet been decided, Powell said.

"It's far more important to think what is the ultimate level and then at a certain point, the question will become how long do we remain restrictive," he said. "I wouldn't see the committee cutting rates until we're confident that inflation is moving down in a sustained way."

WELCOME INFLATION DATA

Powell cheered this week's softer-than-expected consumer prices report but warned some components of inflation may not come down as quickly as goods and housing. CPI rose 7.1% in November, less than analysts anticipated and down from a recent peak of 9.1% in June.

"The inflation data received so far for October and November show a welcome reduction in the monthly pace of price increases. But it will take substantially more evidence to give confidence that inflation is on a sustained downward path," Powell said.

Just over half of the PCE price index is non-housing related core services, and "that's really a function of the labor market" and labor costs. "We do see a very, very strong labor market, one where we haven't seen much softening."

Job growth and wage growth is high, with vacancies still elevated, while the U.S. economy is some 4 million workers short. "We have a ways to go there," Powell said. "That part of (inflation), which is the biggest part, is likely to take a substantial period to get down."

RECESSION?

The positive side of having such a strong labor market may be the higher likelihood of a soft landing, Powell noted.

"We're hearing from many companies that they don't want to lay people off," the Fed chair said. "The fact that there is a strong labor market means that companies will hold on to workers, and it may take longer, and also means that the costs in unemployment may be less."

Fed officials are projection growth around 0.5% next year as the unemployment rate heads to 4.6%, nearly a full percentage point higher than now.

"I don't think anyone knows whether we'll have a recession or not," Powell said.