Jerome Powell, the Federal Reserve chair, made clear Tuesday that the central bank is prepared to react to recent signs of economic strength by raising interest rates higher than previously expected and, if incoming data remain hot, potentially returning to a quicker pace of rate increases.
Powell, in remarks before the Senate Banking Committee, also noted that the Fed’s fight against inflation was “very likely” to come at some cost to the labor market.
His comments are the clearest acknowledgment yet that recent reports showing inflation remains stubborn and the job market remains resilient are likely to shake up the policy trajectory for the United States’ central bank.
Stocks sank on Wall Street after Powell’s remarks. The S&P 500 dropped 1.5 percent Tuesday, and the Dow Jones industrial average gave back 574 points. Both had been nearly flat just before Powell spoke. Treasury yields also shot higher following Powell’s testimony. The yield on the two-year Treasury is near its highest level since 2007.
The Fed last year raised interest rates at the fastest pace since the 1980s, pushing borrowing costs from near zero to above 4.5 percent. That initially seemed to be slowing consumer and business demand and helping inflation to moderate. But a number of recent economic reports have suggested that inflation did not weaken as much as expected last year and remained faster than expected in January, while other data showed hiring remains strong and consumer spending picked up at the start of the year.
While some of that momentum could have owed to mild January weather — conditions allowed for shopping trips and construction — Powell said the unexpected strength will probably require a stronger policy response from the Fed.
“The process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy,” Powell said in his remarks. “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.”
He even opened the door to a faster pace of rate increases if incoming data — which include a jobs report Friday and a fresh inflation report due next week — remains hot. The Fed repeatedly raised rates by three-quarters of a point in 2022, but slowed to half a point in December and a quarter point in early February.
“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,” Powell said.
Before Powell’s remarks, markets were heavily prepared for a quarter-point move at the Fed’s upcoming March 21-22 meeting. After he delivered his opening testimony, investors increasingly bet that the central bank would make a half-point move and stock prices lurched lower.
Wall Street’s widely watched recession indicator also sounded its loudest alarm since the early 1980s. Yields on two-year Treasury bonds rose more than a full percentage point higher than 10-year yields Tuesday, the biggest inversion between the two since 1981. When this measure of the so-called yield curve inverts, it suggests that investors are more worried about the economy in the short term and want to earn higher returns for investing in US debt. It is also seen as a precursor to the economy slipping into a downturn.
While the Fed typically avoids making too much of any single month’s data, Powell signaled that recent reports have caused concern both because signs of continued momentum were broad-based, and because they came alongside revisions that made a slowdown late in 2022 look less pronounced.
“The breadth of the reversal along with revisions to the previous quarter suggests that inflationary pressures are running higher than expected at the time of our previous” meeting, Powell said.
He reiterated that there are some hopeful developments: Goods inflation has slowed, and rent inflation, while high, appears poised to cool down this year.
And Powell noted Tuesday that officials know it takes time for the full effects of monetary policy to be felt, and that they are taking that into account as they think about future policy.
Still, he underlined that “there is little sign of disinflation thus far” in services outside of housing, which includes purchases ranging from restaurant meals to travel and manicures. The Fed has been turning to that measure more and more as a signal of how strong underlying price pressures remain in the economy.
“Nothing about the data suggests to me that we’ve tightened too much,” he said in response to lawmaker questions. “Indeed, it suggests that we still have work to do.”
When the Fed raises interest rates, it slows consumer spending on big credit-based purchases like houses and cars and can dissuade businesses from expanding on borrowed money. As demand for products and demand for workers cools, wage growth eases and unemployment may even rise, further slowing consumption and causing a broader moderation in the economy.
But so far, the job market has been very resilient to the Fed’s moves, with the lowest unemployment rate since 1969, rapid hiring and robust pay gains.
Powell said that wage growth — while it has moderated somewhat — remains too strong to be consistent with a return to 2 percent inflation. When companies are paying more, they are likely to charge more to cover their labor bills. And consumers who are earning more may have more ability to sustain their spending, keeping demand strong enough to allow price increases to persist.
“Strong wage growth is good for workers, but only if it is not eroded by inflation,” Powell said.
Even so, the Fed chair was grilled by some lawmakers Tuesday over what the central bank is expecting to do to the labor market with its policy adjustments.
Senator Elizabeth Warren, Democrat of Massachusetts, suggested that the Fed is trying to “throw people out of work” and that millions of people stand to lose their jobs if unemployment rises as much as central bankers expect.
“I would explain to people, more broadly, that inflation is extremely high, and that it is hurting the working people of this nation badly,” Powell said. “We are taking the only measures that we have to bring inflation down.”
Material from the Associated Press was used in this report.