An important event on Wednesday for investors was the speech of Federal Reserve Chairman Jerome Powell before the Senate Banking Committee. The market began to evaluate new information regarding future interest rate hikes and fresh comments on the state of the US economy.
So, what did Powell say?
The head of the Fed fully justified the expectations of market players about the hawkish mood and noted that the markets read the signals of the central bank quite well. The main headache at the moment is inflation, and all the forces of the Fed will be thrown at this particular ailment of the American economy. To prevent price increases, the central bank will actively and regularly raise rates. This step will definitely be done at the July meeting, and this will happen until inflation begins to backfire. The central bank needs to see serious and sustained signs of slowing inflation, only in this case will the rate hike be stopped.
The Fed's goal is 2% per annum on price indices of consumer spending. Last month, consumer prices jumped by 8.6% compared to the same period last year. Data on PCE indices will be presented on June 30.
"The latest inflation figures indicate that we need to accelerate the pace of rate hikes," Powell said, adding that the 75 bps increase in June was a fully verified and correct decision.
Recall that during a press conference following the meeting, Powell signaled that in July the rate could also be raised by 75 bps. Judging by today's rhetoric, the financial authorities have no other choice and exit. An increase of 75 bps is the minimum that the central bank can do. Judging by the strengthening of Powell's aggressive mood on Wednesday, the increase may be more abrupt.
Powell acknowledged that such inflation rates were quite unexpected and caught everyone by surprise. Now it is clear that the situation is extremely serious, so we should not exclude new surprises not only in the form of inflation. He also added that policy makers need to be more agile in responding to incoming data.
The more precise pace of rate hikes in the future will depend on the economic outlook. The chosen path to stabilize inflation, designed to slow down the economy, has caused widespread concern about the recession and weakening labor markets. It is impossible to do without side effects in the treatment of the disease, so new problems may form somewhere. In general, the American economy, according to Powell, is very strong and has good opportunities for a tighter monetary policy.
The Fed: New realities
Inflation can correct much more and hit much harder than originally expected and is even expected now. Three months ago, financiers were not so concerned about the problems that appeared, and the inflationary environment turned out to be not so threatening.
At the last report to lawmakers, inflation, according to the Fed's preferred indicator, was 6%. It was said that it would begin to decline within a year. After the comments made at the time, there were few signs that prices would go down. It's quite the opposite.
Inflation has also turned into a complex political problem that threatens to tilt the balance of power in Congress in favor of Republicans in the elections this November. Powell was criticized from both the left and the right.
Senator Elizabeth Warren, a Democrat representing Massachusetts, chastised the Fed for raising rates. The risks of a recession that could leave millions of Americans out of work have increased.
A sharp remark about the Fed's reaction to inflation came from Republican Senator John Kennedy of Louisiana. He said that inflation is hitting his voters "so hard that they are coughing up bones."
Republican Senator Tom Tillis from North Carolina, on the contrary, reproached the head of the Fed for the fact that the central bank did not react by raising rates on time, but preferred to sleep through an important time.
Where is the limit of the rate hike
The average forecast of Fed policymakers, published last week, indicates an increase in the target rate to 3.4% by the end of the year. The prices of futures contracts for Fed funds fully take into account the increase by 75 bps at the July meeting. The chances of an increase in the discount rate in the range of 3.50%-3.75% by the end of 2022 are approximately equal.
As for the consequences, according to recent estimates by Fed officials, economic growth will slow to below-trend levels this year. The unemployment rate in the United States, which now stands at 3.6%, will begin to rise. Officials have significantly lowered their expectations about how quickly inflation will decline. The average annual rate forecast for the end of the year was 5.2% according to their preferred indicator from 6.3% as of April. This indicator was 4.3% in March.
In response to Powell's speech, major US stock indexes rose, while Treasury bond yields declined. The dollar index was under pressure. Investors are taking the news favorably that the Fed has decided to firmly fight inflation.
On Wednesday, ahead of Powell's speech, the US currency index developed growth and approached the boundaries of the 105.00 mark. Ideally, it had to overcome this area in order for the recovery to develop momentum in the area of an almost 20-year peak in the 105.80 zone.
Now there is a corrective decline, while the 4-month line in the area of 101.90 restrains the downward trend, the near-term prospects of the index remain positive.
Powell will deliver his second speech to lawmakers on Thursday. Data on business activity in the United States for June will also be published. Market players will be waiting for indications on the further trajectory of the development of the situation in the economy in the light of tightening monetary policy.