Fed Chairman Jerome Powell mentioned disinflation 15 times in a Q&A with reporters this week. The Fed raised interest rates by 25 basis points on Wednesday in its latest tightening move. Powell’s nod to slowing price increases added to market speculation that rates could start falling this year. Something is loading.
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Jerome Powell was keen to remind investors that the economy is still in the throes of a battle with high prices and a potential downturn.
But the Federal Reserve chairman may have been trying to send a different message when he took part in a question-and-answer session with reporters on Wednesday after raising interest rates by 25 basis points.
Powell said it was “gratifying to see the process of disinflation underway,” one of his 15 mentions of the term, while simultaneously warning investors that this process still has a ways to go before rate cuts. can be considered.
For investors who have been optimistic since the start of the year as inflation continues to fall, this has fueled optimism that borrowing costs could start to fall earlier than expected this year.
What did Powell say?
“It’s gratifying to see the process of disinflation getting under way, and we continue to get strong labor market data,” Powell said in his speech Wednesday.
“These are the early stages of disinflation and it is very welcome to be able to say that we are now in disinflation,” he said later in his Q&A, warning that it could take time to trickle down. completely on the economy.
With his repeated mentions of disinflation, Powell was keen to reinforce the idea that price pressures are easing, despite his reminders that this was at an early stage and that “a few more rate hikes” remained likely.
Powell’s constant references to slowing price increases, as well as the idea that financial conditions had tightened – implying that the rate hikes were working – caught investors’ attention, adding fuel to a rally in place for more than a month.
What is disinflation?
Disinflation means slower price increases, and that’s what’s happening in the United States right now. The annual rate of consumer price inflation fell to 6.5% in December, the lowest in more than a year, after a 40-year high of 9.1% in mid-2022.
Core inflation, a gauge that excludes the more volatile energy and food components and is seen as a better indicator of lingering price pressures, also declined on a monthly basis.
Supply chain disruptions, felt around the world since the lifting of COVID-19 restrictions, are beginning to ease, while the more recent reopening of the Chinese economy has helped ease pressures on costs, according to Powell.
“You see inflation coming down now because supply chains have been repaired, demand is returning to services and shortages have been eased,” he said.
The pace at which price pressures abate would be a key factor in the Fed’s rate decisions going forward, following the staggering 450 basis point rise in benchmark rates since last March. If inflation continues to decline towards the central bank’s 2% target, policymakers will run out of reasons to keep rates high.
Deflation has helped lift investor sentiment even with a widely anticipated recession, fueling a nearly 9% rally in US equities year-to-date.
What does this mean for investors?
While markets had already priced in a lower rate hike at the last central bank meeting, Powell’s message still helped stocks gain that day.
Investors appear to be playing chicken with the Fed over the likelihood of it continuing with its plan to cap rates at around 5.1%, which would require two more 25 basis point hikes, or if borrowing costs have reached a top.
Powell has been caught in a bind between trying to remind markets of his intention not to cut rates this year while not forcing a sell-off with overly hawkish rhetoric. According to EY Parthenon chief economist Greg Daco, the result was slightly too dovish.
Powell may adopt a more hawkish tone in the coming weeks to offset Wednesday’s optimism, according to Daco.
“This easing of financial conditions is arguably not what the Fed was aiming for, and we expect a cacophony of Fed rhetoric in the coming weeks will aim to redirect the message,” Daco said in his analysis.
“In other words, the hellish tango will continue as the Fed and the markets try to get back into synchronized rhythms.”
For its part, EY Parthenon said some interest rate cuts remain an “obvious possibility” for 2023.