Powell Says May Need Faster Hikes. Terminal Rate Likely Higher

The Fed is ready to re-accelerate the pace of rate hikes if necessary, Jerome Powell told US lawmakers on Tuesday, in remarks prepared for two days of testimony on Capitol Hill.

Powell conceded, up front, that January’s economic data “partly reversed the softening trends that we had seen just a month ago.”

Although he cited unseasonably warm weather in “much of the country,” he was quick to note that between January’s figures and revisions which suggested the Fed lost momentum in the fight to corral runaway price growth in Q4, inflationary pressures may well be “running higher than expected at the time of our previous FOMC meeting.”

His assessment wasn’t especially rosy, even as it was generally frank. Inflation has moderated “somewhat” since last summer, Powell said, before recapping the Fed’s “three buckets” approach to assessing the situation.

Reduced supply chain frictions have helped core goods inflation recede, and officials expect housing services prices to fall back eventually in keeping with “the flattening out in rents” seen in new leases. But, Powell lamented, “there is little sign of disinflation thus far in the category of core services excluding housing, which accounts for more than half of core consumer expenditures.”

That’s a reiteration of his assessment as delivered during the press conference last month. He said that in order to restore price stability, inflation in core services ex-housing must come down, and that could “very likely” entail “some softening in labor market conditions.” He described nominal wage growth as too hot to be consistent with 2% inflation.

As a reminder, the Fed needs YoY wage growth to fall to roughly 3.5%. Pay growth is much swifter than that in every key category tracked by the Atlanta Fed.

“Strong wage growth is good for workers but only if it is not eroded by inflation,” Powell remarked. He described the labor market as “extremely tight.”

In explaining why the Fed downshifted to quarter-point hike increments, Powell cited Friedman’s “lags,” but the key passage from the testimony found Powell confirming expectations of a higher terminal rate and acknowledging the possibility that the Fed will be forced to go back to half-point increments.

“The process of getting inflation back down to 2% has a long way to go and is likely to be bumpy,” he told lawmakers. “The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” Powell added. “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”