Powell changed everything this week on the market’s outlook on interest rates

Federal Reserve Chairman Jerome Powell’s prepared speech to Congress this week took only a few minutes, but it changed everything.

In those comments, the central bank leader set a new paradigm for how the Fed views its policy path, one that will clearly see interest rates held higher for a longer period of time than before.

The result has forced markets, which have long been looking for the Fed to wink in its inflation battle, to recalibrate its own views to be more in line with policymakers who have been eyeing interest rates. Were warning about the higher-long outlook.

“We clearly had a choreographed chorus of Fed speakers for two weeks that was getting us to that spot,” said Art Hogan, chief market strategist at B. Riley Wealth Management. “It took Jay Powell, during a very brief prepared statement and a Q&A, to bring those expectations to a high.”

As part of his mandatory semiannual testimony on monetary policy, Powell spoke before the Senate Banking Committee on Tuesday and the House Financial Services Committee the day after.

Going by appearances, markets were looking for the Fed to raise its benchmark interest rate by 0.25 percent at its meeting later this month, then perhaps two more steps before pausing, with the end point around 5.25%.

This changed following an appearance by Powell, during which he cautioned that if inflation data remained strong, he expected rates to be raised “higher than previously expected” and possibly faster than a quarter point at a time. Will increase

Markets now strongly expect a half-point hike in March and a peak, or terminal rate, of 5.75% before the Fed expires.

So what changed?

Basically, it was January’s inflation data and signs that the labor market remains remarkably strong despite the Fed’s efforts to slow it. This made Powell, who had only a few weeks earlier talked about “deflationary” forces at play, switch gears and start talking tough on monetary policy again.

“He’s adjusting to incoming data, which is what the whole board should be doing,” Hogan said. “If the facts change again through the February and March figures, he’ll probably be flexible on that side and not take it to the point where they need to break something.”

Indeed, Powell said he would be closely watching an important array of upcoming data — Friday’s nonfarm payrolls report, followed by next week’s look at the consumer and producer price indexes.

Economists at Goldman Sachs are sticking to their forecast of a quarter-point increase at the March 21-22 Federal Open Market Committee meeting, but admit it is a “close call” between that and a half-point.

Should the Fed tilt in a more aggressive direction, Goldman warned in a client note that it could have a market impact, with stocks selling “more quickly” and downward pressure on commodities, as well as upward pressure on the dollar. Is.

Powell faced some questions this week on the Fed’s inflation-fighting strategies.

Some more progressive legislators, such as Sen. Elizabeth Warren, D-Mass., and Rep. Ayanna Pressley, D-Mass., alleged the rate hike would result in 2 million layoffs and would disproportionately hurt working-class families. Powell countered that inflation is also hitting the low end of the income spectrum.

“That’s what he’s going to do,” Joseph Brusuelas, chief economist at advisory firm RSM, said of Powell’s emerging policy position. “Jay Powell is a punching bag in Washington at this point. He’s going to take the blame for establishing price stability. If he does well, he’ll be worshiped for years to come. People will admire him a lot.”

Brusuelles is among those who think the Fed should step up its inflation fight with a half-point rate hike.

However, he added that policymakers could potentially be swayed by a softer jobs report and inflation data next week that reverse course and reflect a price rise. According to Dow Jones, economists expect payrolls to have increased by 225,000 in February, and there is widespread belief that January’s 517,000 increase will be revised down in this report, perhaps significantly.

“The economy is very resilient at this point,” Brusuelas said. “They need to generate enough labor slack to cool the economy.”

The sluggishness was not evident in this week’s Labor Department report of job openings in January, which outnumber available workers by a 1.9 to 1 margin.

According to economists at Nomura, such data could make the Fed tighten even more. The firm said future actions could include adjustments to the Fed’s program to reduce its bond portfolio, with an option to remove the current $95 billion monthly reduction cap.

At the moment, markets continue to price in higher rates.

Although Powell made a specific point on Wednesday that no decision has yet been made on a March rate change, markets essentially ignored him. Traders in the futures market were pricing in a final year-end rate of 5.625%, well above the rate before Powell spoke.