Fed Policy ‘Not Too Tight,’ Powell Says, After Otherwise Balanced Remarks

As expected, Jerome Powell tried to thread the needle on Thursday during closely-watched remarks prepared for The Economic Club of New York.

In this case, “thread the needle” meant reiterating what his colleagues spent the last 10 or so days gingerly telegraphing: The recent increase in long-end US yields, and particularly higher real rates and the ongoing repricing in the term premium, serves to tighten financial conditions. That could (but won’t necessarily) obviate the need for an additional rate hike. He needed to emphasize the impact of higher yields while preserving the Fed’s optionality, while also underscoring the FOMC’s commitment to the inflation fight via restrictive policy for as long as it takes.

Yields, Powell said, have driven financial conditions significantly tighter and in addition to that, there may be meaningful tightening in the pipeline from rate hikes already delivered.

The figure above, which some readers will recognize, illustrates how the term premium’s steep ascent out of negative territory coincided with tighter financial conditions on Goldman’s widely-cited index.

Sharp changes in financial conditions can affect policy if they’re “persistent,” Powell’s remarks said. Later, during the Q&A with David Westin, Powell said yield increases could reduce the need to raise rates at the margin, but said he’s not advocating for any specific level of long-end yields.

The Fed’s proceeding carefully in light of the rapid rate hikes the FOMC delivered this cycle, his speech read, noting that there are myriad risks, not least among them geopolitical concerns.

Many indicators suggest the labor market is cooling gradually, even as the jobs market is obviously still quite tight. The path to price stability will be “bumpy,” according to the address, and it’s going to take some time. If there’s “additional evidence” that the US economy is running too hot, or is too strong to be consistent with the Fed’s inflation-fighting efforts, more hikes could be necessary, according to Powell.

The festivities were interrupted by climate protesters. Powell was briefly escorted out of the room. Don’t worry: He was fine. There was no confetti shower.

During the Q&A, Powell said it may be that rates haven’t been high enough for long enough. He conceded that the economy might not be as susceptible to rate hikes this cycle as it has been in the past. Still, the Fed thinks policy is working through the usual channels and doesn’t see a fundamental shift in the way rates affect the economy. I’d quibble with that assessment. Others would too.

As ever, Powell tried to be humble about what the Fed does and doesn’t know. There’s no precision in the FOMC’s understanding of how long (or variable) the lags with which policy acts really are in any given cycle. The Fed slowed down this year to give policy time to work.

He wouldn’t speculate on the longer-term neutral rate, but reiterated that it might’ve risen in the near-term. The economy appears to be handling higher rates well, he said, adding that the evidence suggests policy isn’t too tight right now.

Pressed by Westin on the neutral rate, Powell said that,

We have models for everything, we have formulas for everything. Ultimately, as a practitioner, we have to focus on what the economy is telling us. Does it feel like policy is too tight right now? I would have to say no.

That was probably the key takeaway from Thursday’s event, although Powell likely didn’t mean to make waves.

He also said the recent increase in bond yields in the US is mostly due to term premium repricing and suggested that the main risk to the economy remains high inflation.