Powell says economy can withstand Fed tightening, Omicron surge

Powell says economy can withstand Fed tightening, Omicron surge
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(Jan 11): The Federal Reserve's plans to tighten monetary policy this year shouldn't undercut strong employment in an economy that "no longer needs or wants" the massive stimulus the US central bank has provided, Fed Chair Jerome Powell said on Tuesday.

Powell, in testimony before the US Senate Banking Committee, said he expected the country to power through the current surge in coronavirus cases, with any impact on the economy "short-lived" and likely not derailing Fed plans to raise interest rates and decrease its asset holdings this year.

Powell told the lawmakers, who appeared to be leaning towards endorsing him for a second four-year term, that it was now inflation - not promoting more job growth or guarding against a coronavirus downturn — that is the Fed's main focus given that price increases are running at a 40-year high and well beyond the Fed's 2% target.

Indeed, Powell told the Democratic-controlled panel that stabilising prices was necessary to keep an economic expansion and employment growth underway.

"Inflation is running very far above target. The economy no longer needs or wants the very accommodative policies we have had in place," Powell said. But "it is a long road" to get monetary policy back to normal, and while it was time to end the Fed's pandemic emergency policies, that "should not have negative effects on the employment market."

Inflation was a focus of lawmakers during the hearing, and Powell said he still felt that while the level of price increases required the Fed to act, some relief would come from beyond monetary policy as global supply chains start to catch up with demand. Mistakenly expecting that adjustment to happen fast, Powell said, is why the Fed at first dismissed rising inflation last year as "transitory", only to see it continue to increase.

He said he now thinks inflation will ease by the middle of this year, but that the Fed stood ready to do what was needed to keep high rates of price increases from becoming "entrenched".

"We are going to have to be humble but a bit nimble," Powell said, in deciding when and how fast to raise interest rates and change the Fed's asset holdings, which have ballooned to more than US$8 trillion as a result of its pandemic-related support for the economy. Powell said no decision had been made about normalising policy, but that it was likely the Fed would decide to let the balance sheet shrink "sooner and faster" than it did following the 2007-2009 recession.

US stocks, which have started the year on weak note as the Omicron variant fueled a surge in Covid-19 cases and investors repositioned for a Fed that is more intent on containing inflation through higher interest rates, edged up during Powell's testimony. Yields on shorter-dated Treasury securities backed down from pandemic-era highs reached earlier in the session.

Interest rates

The hearing is a first step in Powell's expected confirmation by the full Senate to a new four-year term as Fed chair. Lael Brainard, currently a Fed governor, will be questioned by the same panel on Thursday for promotion to a four-year term as Fed vice chair.

The positions require majority approval by the full Senate, which is narrowly controlled by President Joe Biden's Democrats.

At the start of Tuesday's session, Democratic Senator Sherrod Brown, the panel's chair, and Senator Pat Toomey, its senior Republican, endorsed Powell's management of the Fed's response to the pandemic, even as they raised questions about its next steps.

"I believe you've shown the leadership" to lead the Fed through debates over inflation, regulation, and an ethics scandal over stock trading by senior officials, Brown said.

Toomey said he was concerned that the Fed's robust response to the pandemic may now be stoking inflation and "could become the new normal", and repeated his criticism of the central bank delving into what he regards as political issues like climate change and inequality.

Even as the pandemic continues, inflation has emerged as the Fed's chief concern.

In December, the central bank decided to end its purchases of Treasuries and mortgage-backed securities — a legacy of its nearly two-year battle with the economic fallout of the pandemic — by March, and signaled it could raise interest rates three times this year.

Since then, Covid-19 infections have surged to daily records, with hospitalisations rising and quarantining employees sapping an already stretched labour supply, and some observers expect the mismatch between supply and demand that is putting upward pressure on prices to intensify further.

Investors and traders will be listening for new clues on when the Fed may begin raising interest rates and possibly reduce its bond holdings to bring down inflation.

Financial markets are pricing in an aggressive response, with interest rate futures traders betting on four rate hikes this year.

Powell may face tough questions both from some Democrats, including Senator Elizabeth Warren, who has said she opposes his renomination because she sees him as too easy on Wall Street, and from some Republicans who have publicly worried the Fed is responding too late to rising prices.