Source: Wall Street Journal.
Author: Li Dan

After the Federal Reserve announced it would continue to pause interest rate cuts and raise inflation expectations while lowering economic expectations, Fed Chair Powell reiterated that the Fed does not need to rush to adjust its monetary policy stance, stating that they are well-prepared and will patiently wait for clearer market information. "We believe now is a good time to wait for further clarification."

Powell pointed out that external surveys indicate tariffs are driving inflation expectations; however, longer-term inflation expectations still align with the Fed's 2% inflation target. He acknowledges that external predictions of the probability of a recession have increased, but believes this probability still falls within a moderate level, stating that the risk of recession "has increased but is still not high."

Nick Timiraos, a senior Fed reporter known as the "New Fed Communications Agency", commented that in recent weeks, headlines about the U.S. federal government cutting spending and raising tariffs have significantly dampened domestic Consumer confidence. This time, Powell did not send a more aggressive signal regarding possible price increases related to tariffs, which cheered investors.

Long-term inflation expectations remain stable, therefore the Federal Reserve can ignore the impact of tariffs on inflation.

On March 19th, Wednesday, Eastern Time, at the beginning of the press conference following the Federal Open Market Committee's monetary policy meeting, when asked how much of the Federal Reserve's increase in inflation expectations was caused by tariffs, Powell responded that it is difficult to analyze to what extent inflation is driven by tariffs, but the Fed will try to figure this out:

"Clearly, a part of it, a large part (a good part of) comes from tariffs."

Powell stated that it is still too early to determine whether the initial inflation impact related to tariffs can be ignored. He noted that if long-term inflation expectations can be well controlled, the Federal Reserve can ignore the one-time shocks from policies like tariffs.

Powell believes that the recent rise in inflation is largely related to tariffs, but pointed out that long-term inflation expectations have stabilized, allowing the Federal Reserve to overlook it.

Powell reiterated that the Federal Reserve may lower interest rates in the event of an unexpectedly weak labor market or an unexpected decline in inflation. If the inflation rate cannot continue to approach the Federal Reserve's target of 2%, "we can maintain (monetary) policy restrictions for a longer period."

Powell said:

"As I have mentioned, sometimes if inflation would quickly disappear without our action, if it is transitory, then it is appropriate to ignore inflation. The situation with tariff inflation (the tariff inflation) may be like this. I think it depends on whether we can quickly get through tariff inflation."

Therefore, he stated that the inflation caused by tariffs will be temporary and remains the "baseline" forecast scenario. He pointed out that during Trump’s first presidential term, "the last time tariffs were imposed," the impact on inflation was also temporary.

Powell said that excluding tariffs, the basic inflation rate is about 2.5%. He found "no reason" to expect a repeat of the great inflation in the USA during the 1970s.

Commentators stated that Powell’s term "tariff inflation" seems to intentionally separate the inflation caused by tariffs from other inflation scenarios.

After Powell mentioned the impact of tariffs on inflation, the yield on the two-year US Treasury bond, which is sensitive to interest rates, further widened its intraday decline, dropping below the psychological threshold of 4.0% at midday, plunging over 10 basis points from an intraday high of nearly 4.09% prior to the Federal Reserve’s announcement.

Although the baseline forecast indicates that tariffs will not lead to sustained acceleration of inflation, Powell also said, "We really do not know. We must see how the situation actually develops."

Powell cautiously reiterated that "survey respondents" pointed out the impact of tariffs, while also noting that a recent New York Fed survey on inflation expectations shows that long-term inflation expectations remain stable. He stated that market indicators also reflect this. From the long-term inflation expectations derived from bond market indicators, there are no signs of inflation rising. The five-year, five-year-ahead expected inflation rate shows that long-term inflation expectations have remained stable.

Partially due to tariffs, the progress of inflation decline this year may be delayed.

Powell commented, "Currently, we do see quite robust hard data (on the economy)," and employment growth is "at a healthy level."

Powell stated, "The relationship between survey data and actual economic data is not very tight. But we do not know if this is the case here. We will closely monitor for signs of weakness in the actual data."

Powell reiterated that the inflationary impact caused by tariffs may lead to a delay in further progress towards cooling inflation. He said:

"We believe that inflation has begun to rise now, partly due to the impact of tariffs, and this year further progress in (lowering inflation) may be delayed."

When asked whether the policies of the Trump administration have had an impact on the data, Powell stated, "It is too early to predict significant effects on economic data now."

Still optimistic about the employment outlook, the unemployment rate is "very close to its natural level."

When asked whether the Federal Reserve would further cut its economic outlook for this year, Powell's response reflected the current difficulty in predicting the effects of tariffs and other policies, saying, "It's really hard to know how things will develop."

Despite the economic outlook released by the Federal Reserve on Wednesday showing that Fed officials significantly downgraded their GDP growth expectations for the USA this year, Powell's remarks showed that he remains optimistic about the employment outlook.

He stated that the unemployment rate is "very close to its natural level." Currently, it is in an environment of "low layoffs, low hiring," and this situation has remained "balanced" for about the past six months. However, the Federal Reserve is carefully monitoring this situation because a significant increase in layoffs combined with low hiring rates will "quickly" lead to unemployment.

External forecasters have increased the likelihood of an economic recession, but it remains at a "relatively mild level."

Powell acknowledged that the risk of an economic recession may have increased in recent months, but he tried to reassure the public by pointing out that the likelihood of a recession is still very low.

Powell said:

"The possibility of a recession always exists. Looking back, the chances of a recession have probably been around one in four at any given time. The question is whether the current situation has raised those possibilities."

Powell pointed out that the Federal Reserve itself does not make predictions about economic recessions, although the Atlanta Fed has a "GDPNow" tool that recently predicted a slight contraction of the US economy this quarter. He also noted that external forecasters have raised the likelihood of a recession in recent weeks.

Powell said that forecasters have generally increased their expectations for the probability of an economic recession, but that possibility "remains at a relatively mild level" and that "two months ago, people said the chances of a recession were extremely low. So it has changed somewhat, but not significantly."

He added, "All forecasters have predicted tariff inflation. I don't know of any exceptions."

Soft data weakness may be related to the turmoil during Trump's early presidency; Michigan University's inflation expectations data is an "outlier."

A recent series of economic surveys has raised concerns about the economic outlook. However, Powell believes that this 'soft' data does not necessarily indicate economic weakness, 'it could be related to the turbulence in the early days of a government administration.' He also pointed out that Americans' fundamental dissatisfaction with the economy may lie in the price level.

Powell stated that 'hard' data shows low unemployment rates, healthy job growth, and a slowdown in consumer spending but still robust, indicating that the US economy is 'healthy.'

'Soft' data often refers to surveys, which are generally viewed as more subjective indicators of economic activity. In contrast, hard data, such as economic reports, are seen as clearer and more objective indicators. He said:

'The relationship between survey data and economic activity is not very tight. Sometimes people express very pessimistic views about the economy and then go out and buy a new car.'

Powell stated that the consumer inflation expectations data from the University of Michigan survey is 'an outlier,' but the Federal Reserve has taken note of this.

When asked how the Federal Reserve would respond to stagflation, Powell indicated that the Federal Reserve would examine how far off the targets for employment and inflation are and understand how long it will take to reach each target. He said that stagflation is a very challenging situation, but we have not reached that point yet.

When asked about the stock market pullback and how it might affect business confidence and spending by high-income households, Powell stated that it is important for the Federal Reserve to see significant and persistent changes in a broader range of financial conditions.

Powell said he would not express 'opinions' on any specific market. He reiterated that hard data remains solid. He noted that the 'soft' survey data has deteriorated, which cannot be ignored. But currently, hard data remains robust.

Slowing down the balance sheet reduction has not released any signals, allowing QT to persist longer.

The Federal Reserve stated in its decision announcement last Wednesday that it will slow down the pace of reducing the balance sheet (QT) starting in April, significantly reducing the amount of US Treasury bonds held by lowering the monthly redemption limit from 25 billion dollars to 5 billion dollars, an 80% reduction, while not adjusting the redemption limits for agency debt and agency mortgage-backed securities (MBS).

Powell stated that if QT is slowed down, the path of QT will become longer. The last time the Fed slowed QT, "people really liked doing it," and it is possible to "slow down the pace and continue for a longer time."

He also mentioned that the Fed has not released any signals by slowing QT. Slowing down can allow the Fed to approach its desired level of "adequate" reserves more gradually. There are no plans to slow the reduction of MBS held by the Fed.

Powell acknowledged that the USA federal government debt ceiling has led to a reduction in the balance of the General Account (TGA) used by the Treasury for holding taxes and other government revenue and expenditure, prompting the Fed to discuss slowing QT. While discussing this QT decision, he mentioned that the Fed considered pausing QT and also considered slowing it down, which indeed received strong support.

Removing the language about balancing employment and inflation risks does not mean greater concern about those risks.

The Fed's decision statement removed the phrase about balancing employment and inflation risk overall. A reporter asked whether deleting this phrase means that the Fed is more worried about inflation or employment.

Powell responded that it is not as serious as it seems. "This does not actually represent any kind of (concern) situation. Sometimes, language plays its role, and then we delete it. That's the way it is. This really isn't meant to send any signals."

Powell stated that when the Federal Reserve begins to shift from punitive rate hikes to easing or maintaining interest rates, that statement is useful language. "We have passed that stage, so we removed it."

Editor/Jeffy