Source: Wall Street News
Author: Zhao Yuhe

On Wednesday, May 1, EST, the Federal Reserve announced at the Monetary Policy Committee FOMC that the target range for the federal funds rate is still 5.25% to 5.50%, while QT will slow down from June, as expected by the market.

Federal Reserve Chairman Powell said at the press conference that followed that when it comes to cutting interest rates, it will take longer than originally anticipated to gain confidence. Short-term inflation expectations have already risen, but the next step is unlikely to be to raise interest rates. The three major US stock indices rose more than 1% after Powell's speech, but after full digestion, the S&P 500 index and the Nasdaq index finally closed down.

Powell said that the Federal Reserve is committed to carrying out its dual responsibilities, and the US economy has made significant progress towards achieving full employment and maintaining price stability. He briefly reviewed the recent state of the US economy. He said that the latest economic indicators show that the US economy continues to expand at a steady pace. Despite high interest rates putting pressure on investment in housing and equipment, consumer spending has remained strong over the past few quarters, and improved supply conditions have supported elastic demand.

At the same time, Powell said that the labor market is still relatively tight, the balance has improved, the labor supply is still oversupplied, the labor participation rate of people aged 25 to 34 is rising, and the continuous wave of immigrants has also increased the supply of the labor market. The gap between jobs and the number of workers has narrowed. Labor demand is still strong, but it has cooled down from its peak since the COVID-19 pandemic, he said.

Powell, although inflation has slowed significantly in the past year, it is still above the 2% target. There is no further progress in fighting inflation. The US inflation data so far in 2024 has been higher than expected. He said that short-term inflation expectations have risen, long-term inflation expectations are stabilizing, the economic outlook is still uncertain, and the Federal Reserve will still pay close attention to inflation risks.

Powell said that high inflation has caused major difficulties for people and eroded purchasing power, especially for low-income groups. Unless the Fed has more confidence that inflation continues to move towards the 2% target, the Fed is not expected to lower the target range of the federal funds rate. He said that so far this year, the data has been higher than expected and has not brought such greater confidence.

Powell said that as far as interest rate cuts are concerned, gaining confidence will take longer than originally thought. The Federal Reserve is preparing to maintain the current interest rate range for an appropriate period of time, and is also prepared to deal with unexpected weakness in the labor market. The FOMC will make decisions meeting by meeting based on data.

“Reducing policy restrictions too soon or too much could weaken our progress on inflation. At the same time, reducing policy restrictions too late or too little may unduly weaken economic activity and employment. The FOMC will carefully evaluate upcoming data, changing prospects, and risk balance when considering any adjustments to the federal funds rate target range.”

In the Q&A session that followed, Powell claimed that the FOMC's next move was unlikely to raise interest rates. “I do think it's clear that the policy is restrictive,” Powell said. “We are confident that it will be sufficiently restrictive over time.”

Regarding the slowdown in QT, Powell said that starting June 1, the maximum redemption limit of the Federal Reserve's treasury bonds will be reduced from the current 60 billion US dollars per month to 25 billion US dollars. He said that the decision to slow down QT does not mean that the Fed's balance sheet will eventually shrink less than originally anticipated, but rather that it will gradually approach its final level.

Here's a summary of the Q&A session:

Q1: Are you still convinced that current interest rates are sufficient to curb inflation and return to 2%? Is it restrictive enough?

Powell: I do think the evidence is very clear that current monetary policy is restrictive and is having an impact on demand. In this regard, I can point out a few aspects. First, demand in the labor market is still strong, but it has cooled down from a very high level a few years ago, as can be seen from job vacancies. The turnover and recruitment rates have largely been normalized.

On the spending side, such as housing and investments, you can also see that higher interest rates are putting pressure on these activities. We believe it will be restrictive enough over time.

Q2: Federal Reserve Governor Michelle Bowman previously anticipated the risk of interest rate hikes. Do you also think there is such a risk? Under what circumstances would you consider raising interest rates?

Powell: I don't think the next policy interest rate adjustment is likely to raise interest rates; I'd say this is unlikely. You know, our policy focus is actually what I just mentioned, and that is the length of time to keep the policy restrictive.

So what are the conditions required to raise interest rates? We need to see strong evidence that our policy interest rate is insufficient to reduce inflation to 2%. But that's not what we're seeing right now, as we mentioned. We'll look at all the data to answer this question, including inflation, inflation expectations, and everything else. I mean if we come to the conclusion that policies aren't tight enough to achieve that goal. Therefore, this is going to be a comprehensive look at the problem; it may be an expectation, it may be a combination of factors, and see if we can come to such a conclusion. However, we have not seen any evidence to support this conclusion to support further interest rate hikes.

Q3: You didn't mention today that it is more appropriate to cut interest rates later this year. This is different from what you said at the previous press conference. So, has the Federal Reserve given up on its easing tendencies? What's your position? Will inflation be the key data for decision-making?

Powell: Well, let me talk about cutting interest rates. Obviously, our decision on policy interest rates will depend on upcoming data, the evolution of the economic outlook, and risk balance. We'll consider all the data. We believe that the current monetary policy is well positioned to respond to the possibility that the economy may take different paths.

We have stated that it is inappropriate to ease restrictions on monetary policy until we have greater confidence that inflation will continue to fall to 2%. For example, if we experience a situation where inflation lasts longer than expected, such as the labor market remains strong while inflation moves sideways, we don't gain more confidence. In this case, it may be appropriate to delay interest rate cuts.

I think the economy may take a different path. There are two situations that may give us more confidence in cutting interest rates. One is that inflation will continue to fall to 2%, and the other may be an unexpected weakening of the labor market. These are possible paths to cut interest rates. I think it depends on the data. Of course, one aspect we will focus on is the performance of inflation. We will keep an eye on inflation expectations. We'll keep an eye on the whole situation. Obviously, future inflation data will be central to interest rate policy decisions.

Q4: To what extent has the suspension of interest rate hikes since November last year accelerated economic growth? Do you now anticipate a period of continued austerity to ensure that last year's trend of slowing inflation continues? You've said in the past that stronger economic growth won't necessarily stop interest rate cuts. If the labor market continues to be strong and wage growth accelerates, will you change your mind?

Powell: That's hard to say. In fact, the growth we saw in the first quarter of this year was roughly the same as last year, and there was no acceleration. It is generally believed that the suspension of interest rate hikes in December last year and the relaxation of the financial environment will lead to an increase in economic activity, which in turn will lead to inflation or a tightening of the labor market, but this has not actually happened. The reality is that the level of economic activity is roughly the same as last year. So what is causing this inflation? We'll get to know better over time. I don't see a clear link between economic conditions and a relaxed financial environment.

As far as austerity is concerned, interest rates are now higher than they were before the December meeting last year, and have been around for some time. This is appropriate given the inflation situation in the first quarter, considering the inflation situation in the first quarter.

The prudent statement is that we don't set targets for wage growth or the labor market. Last year we saw strong growth, a tight labor market, and a historic rapid decline in inflation. This is because we know that two forces are at work here. One is the removal of supply-side and demand-side distortions associated with the pandemic, and the other is restrictive monetary policy.

I won't rule out the possibility that a similar situation cannot continue. It's not impossible for this to happen again on the supply side, as we do see companies still reporting that they are facing supply-side issues. Even if the supply-side problem is solved, it will take some time to affect economic activity and, ultimately, inflation.

I don't like to say that a growing or strong labor market itself automatically creates problems with inflation. Of course, this wasn't the case last year. We also don't set targets for wages; our goal is to control inflation. Wages are one of the influencing factors. Regarding wages, of course we want to see higher wages, but we also want wages not to be eroded by high inflation. This is exactly what we are trying to do, which is to cool the economy and bring the economy back to 2% inflation in line with supply-side changes. Part of this may be gradually reducing wage growth to a more sustainable level.

Q5: You talked about targeting a slow decline in inflation to 2%. It's May now. Considering the dates, do you still have time to cut interest rates three times this year? Looking back at the data for the first three months of this year, are there any signs that the situation is more worrying than the bumpy inflation expectations?

Powell: I'm not thinking about it that way; what we're saying is we need more confidence. We didn't see any progress in the first quarter, and I'd say it looks like it will take longer to reach that level of confidence. I have no idea how long this will take. All I can say is that when we gain that kind of confidence, interest rate cuts will come into consideration. I don't know exactly when that will be.

There are no more worrying signs right now. So I think it's appropriate to keep the current judgment until we have data for the entire quarter. Taking a step back, what are we seeing now from the first quarter? Strong economic activity. We are seeing a strong labor market. We've seen inflation. We saw three inflation readings. I think that's where you should get some signals from it. We don't like to react to a month or two of data. We're getting signals. The signal we get is that it may take longer for us to get to the 2% inflation path. That's the signal we got.

Q6: In the inflation data for the first quarter, what issues do you think are temporary? How will the next few months or quarters unfold? Is there a contradiction between slowing QT and maintaining high interest rates?

POWELL: Yes. We've carefully analyzed the data, and nothing in it will change our opinion. In fact, we didn't gain confidence, and think it would take longer to gain that confidence.

Since December of last year, you've seen higher than expected commodity inflation and higher than expected non-residential services inflation. The combination of these two is higher than we expected. There is a reason behind this they happened. Also, I think my expectation is that at some point this year, we'll see inflation fall back. This is my prediction. But because of the data we've seen, I'm less confident about this than before.

I don't think there is a contradiction between slowing down QT and maintaining high interest rates. The active instrument of monetary policy is, of course, interest rates. Slowing down QT is a plan we have had for a long time. The purpose is only to slow down the speed, not to facilitate the economy or make the economy less restrictive. This is actually to ensure that the balance sheet contraction process runs smoothly and does not cause financial market turmoil like the last time we did this.

Q7: Considering the data since March, do you think the possibility of not cutting interest rates this year has increased or remained the same? I think the concerns about inflation are excessive; would you be more patient with inflation falling as the economic cycle progresses?

Powell: I can't estimate the possibility of not cutting interest rates. But all I can say is that it is inappropriate to cut interest rates until we have more confidence that inflation will continue to fall to 2%. Our confidence in this did not increase in the first quarter. In fact, our opinion is that it will take longer to gain that confidence. I think the path of the economy has always been difficult to predict for a wide range of forecasters.

However, there are ways not to cut interest rates, and there are also ways to cut interest rates. It really depends on the data. Of the two major tasks of the Federal Reserve, if one is further away from the target, then you focus on that one. Previously, the inflation problem was obviously more serious. With inflation now falling below 3% on a 12-month basis, we are now shifting our focus to employment. That's how we think about this.

Q8: Is your understanding correct that inflation is most likely to occur if interest rates are lowered to lower than current levels at the end of the year? Also, key GDP data has sparked discussions about the “stagflation” of the US economy. Does the Federal Reserve now consider this a risk?

Powell: I'm not actually dealing with possibilities. Among the paths that economic trends can take, some may involve interest rate cuts, while others may not. I'm not very confident about which of these paths will happen.

My personal prediction is that we will see further progress in inflation this year. But I don't know if this prediction is sufficient; it requires data to guide us.

Regarding stagflation, I have experienced stagflation, which is a 10% unemployment rate, high single-digit inflation, and very slow economic growth. Now we have 3% growth, and I'd say that's pretty solid growth by any standard. Also, our inflation rate is below 3%. So I really don't understand where the idea of stagflation comes from. In fact, I'm not seeing any signs of stagflation.

Q9: Earlier, the FOMC Vice Chairman said that potential growth has improved. Do you agree? Does this mean that monetary policy is still not tight enough? If you say you haven't really considered raising interest rates, but if growth is higher and you still don't consider raising interest rates, does that mean you're more concerned about an excessive economic slowdown rather than another rise in inflation?

Powell: We saw very high economic growth in 2023, while in 2022 we saw negative productivity growth. So, I think it's hard to draw conclusions from the data. The question is, will productivity continue to rise above long-term levels? I don't think we know. This is a separate issue in terms of potential economic output. We have experienced a significant increase in the economy's potential output, which is not related to productivity. This is actually due to having a larger workforce, through increased labor participation rates, and through immigration.

So we're very much like other forecasters and economists. We're working to understand what this means for potential output this year, next year, and last year. In this case, I think you're actually seeing a significant increase in potential output. But you're also getting more supply, and more people are entering the labor market. They have jobs, consumption, and demand. At first, supply may exceed demand. But in the end, it should be neither inflationary nor deflationary for a longer period of time.

I think we believe our monetary policy position is well-positioned and suited to the current situation. We think it's restrictive. Also, I've talked about some evidence before, which can be seen in the labor market and consumption. Demand has dropped drastically over the past few years.

Q10: The GDP growth rate is now around 2%, and the unemployment rate is around 4%, which feels like a steady state. Currently, we have 3% inflation. Although you say you don't see the possibility of interest rate hikes, it is reasonable to say that to reduce inflation from 3% to 2%, interest rate hikes are needed. Was the question of interest rate hikes discussed during today's meeting? Are you happy with 3% inflation for the rest of the year? Is there a time frame for sustained inflation to trigger interest rate hikes?

Powell: 3% inflation is unlikely to satisfy us, so we will restore inflation to 2% over time, and we think our policy position is appropriate for this. So if we come to the conclusion that policies are insufficient to keep the inflation rate below 2%, then this would be a reason we want to raise interest rates, but we have seen no such evidence so far. This is where we are now.

The policy focus of the FOMC meeting has always been on how to maintain the current level of monetary policy restrictions. That's part of the policy. The policy discussions at the conference were about this.

There is no time frame for interest rate hikes. Clearly, restrictive monetary policies need more time to work. This is very clear based on what we've seen. How long this will take and how much patience we should have depends on the overall picture of all the data and how the outlook evolves.

Q11: You mentioned the non-partisanship nature of the Federal Reserve. Considering that this year is an election year, is it more difficult to raise interest rates at this time? Similarly, is there any significant economic difference between cutting interest rates starting in September and cutting interest rates in December?

Powell: When we agree that this is the right thing to do for the economy, we always do what we think is right for the economy. We don't think about anything else; just getting the economy done is difficult enough. If we were to consider a whole set of other factors, that would reduce our chances of properly dealing with economic issues. Our decisions are based on data and how that data affects the outlook and risk balance. Elections are not in our mind.

Q12: You mentioned that the labor market is being normalized. Can you share an analysis of why this is happening. Is this a lagging indicator?

Powell: Wage growth peaked about two or three years ago. Labor costs in all industries have declined significantly since then, but not as low as pre-pandemic levels; they are still about 1 percentage point higher than before the pandemic. We've seen quite consistent progress on this point, but it's not uniform. There was a drop in the ECI reading on Tuesday, but it was actually flat year over year, which I think is roughly the case.

Again, we don't set targets for wage growth. However, in the long run, if you have wage growth that exceeds what productivity can support, then there will be inflationary pressure. If this is the case, employers will raise wages over time. So, we've seen progress, but it's inconsistent, and we've seen a sharp drop in overall labor costs. But we still have a long way to go in this regard.

Q13: Now consumers are feeling pressure from interest rates. Mortgage interest rates have risen, as have car loans and credit cards. People are discouraged by borrowing. This is their view of the economy. What do you have to say to them? Can current policies be effective enough to fight inflation?

Powell: Inflation hurts everyone, especially the lower income groups. If you are a salaried person, suddenly the price of everything you buy, the necessities of life, has gone up. You'll soon be in trouble.

So with these people in mind, what we're doing is using our tools to reduce inflation. This will take some time. But we will succeed. We will reduce the inflation rate back to 2%. Then people don't have to worry anymore. That's what we're doing. We know it's painful and inconvenient, but the benefits are huge in the long run. Everyone will share in these rewards. We've made quite a bit of progress. If you think about it, our core PCE inflation rate used to be as high as 7.1%, now it's 2.7%.

Restrictive monetary policies are playing their due role. But what's different this time is that the supply side also needs to recover as well. A large part of this inflation is due to a collapse on the supply side. This is related to the economic shutdown and reopening before and after the pandemic. There are also factors that really increase demand. Therefore, supply and demand must go hand in hand. The reversal of supply and demand distortions caused by the pandemic, combined with restrictive monetary policies. These two things are working together to reduce inflation. We have made progress. We still have work to do, but we're no longer facing the very high rate of inflation we had two years ago.

Q14: Inflation relief in the housing sector is yet to come. How do you explain the significant lag we're seeing between private sector data and government data? How confident are you that rents over the next few months will help the inflation outlook?

Powell: Basically, there is a lag in many areas of the economy during the inflation process; housing is one of them. Therefore, when someone goes to rent a new apartment, there is a so-called market rent. You can see that there has been little increase in market rents. Inflation in this part is very low. But before that, they were very high, and at one point led to inflation. Therefore, it will actually take several years for these market rents to be fully reflected in the rent of the renewing tenants.

Landlords usually don't raise rents drastically for tenants who renew their leases. This has caused an accumulation of unrealized rent increases, causing rents for new tenants to increase dramatically in the future. It's complicated, and it takes some time to materialize. As long as market rents remain low, this will be shown in inflation data. I think we've realized that the lag will be much longer than initially thought. It may be unpredictable in terms of time, but it will happen.

Q15: Most central banks in developed countries have adopted similar policy paths in the past three to four years, but based on economic data from Europe, the US, Japan, and their central banks, this sense of unity will end this year. So what are the considerations or risks for the FOMC that are more divided between the global economy and central bank policies?

Powell: Yes, you're right. I think that might happen. You know we're all serving domestic missions, right? So I think the difference between the US and other countries now considering cutting interest rates is that they don't have the kind of growth we have experienced. Their inflation performance is roughly similar to ours, and maybe slightly better. But they haven't experienced the growth we've experienced. So we actually have strong growth and a strong labor market, and a very low unemployment rate, etc.

So we can be patient, and we will be careful when deciding to cut interest rates. And I think other regions might act ahead of schedule. As for the impact, you know, I think it's clear that the market has anticipated this and is now factored into the price. So I think the market and economy can adapt to it. Furthermore, for emerging market economies, we are not seeing more frequent turbulence 20 or 30 years ago. I think this is partly because emerging market economies have more credit for inflation. So, this time they handled it pretty well.

Q16: Given the strong inflation data for the first quarter, can the economy follow a relatively painless path to reducing inflation? Or maybe some weakness in the labor market and economy is necessary to reduce inflation? If the unemployment rate rises to 4% and inflation hasn't fallen back to 2%, what would you think? Will the 4% unemployment rate be noticed?

POWELL: You're right. We previously believed that there must be considerable turmoil in some part of the economy, such as the labor market, to reduce inflation from the very high level at the beginning of this stage. But that didn't happen. This is a huge achievement. We're very glad this didn't happen. A large part of this is due to the resolution of crises unrelated to monetary policy, such as supply-side distortions. The resolution of these issues has indeed helped reduce inflation. Now, as I said, I'm not giving up on that. I think these forces will still work to help us reduce inflation.

We can't guarantee this will happen all the time, so we're trying to use our tools in a way to keep the labor market strong and the economy strong, but it also helps keep inflation down to 2%. We want to be able to do this without causing major disruptions in the labor market or elsewhere.

Note, I'm describing unexpected weakness. We believe that the labor market will only respond when it does weaken significantly; an increase in the unemployment rate by a few percentage points may not cause such a reaction. Whether or not you decide to cut interest rates will depend on all facts and circumstances.

Q17: You said that the final Basel III proposal requires extensive and substantial reforms. Do you have a timeline in mind when you will take action in this regard? Is it a re-proposal?

Powell: Let me first say that the Federal Reserve will abide by its commitment to participate in Basel III, but the US regulators have yet to decide on the capital system proposal. If it is necessary to re-propose a capital system, the Federal Reserve will do so without hesitation.

Q18: We haven't seen much objection within the FOMC, how can you avoid collective decision-making mistakes and reduce the greater risk of policy mistakes?

Powell: If you listen to 18 FOMC colleagues express their opinions, you'll see that we don't lack diversity. This is one of our major strengths. We have 12 Federal Reserve banks, and they have their own economic teams. As a result, every reserve bank has its own culture of monetary policy, and its own methods and characteristics. This guarantees diversity of views. I think the opinions are very diverse.

In terms of objections, we have objections. A well-considered objection is a good thing. Someone actually made you think. From my point of view, I listen carefully to other people's opinions. I'm trying to incorporate their ideas into what we're doing. I think we're sitting around the table with a very diverse group of people.

Editor/Jeffy