New York, Oct. 19 (BNA): The U.S. economy’s strength and continued tight labor markets could require still tougher borrowing conditions to control inflation, Fed Chair Jerome Powell said on Thursday, though rising market interest rates could make action by the central bank itself less necessary.
Appearing to align himself with Fed colleagues who have recently said the bond market is now doing some of the central bank’s work for it, Powell in remarks to the Economic Club of New York agreed “in principle” that the rise in yields was helping to further tighten financial conditions and “at the margin” might lessen the need for additional Fed rate increases, Reuters reported.
It was not an explicit endorsement of that view, but financial markets seemed to read it as one. As Powell spoke investors leaned further into bets that the Fed is done raising its short-term benchmark interest rate. Futures that settle to the Fed’s policy rate are now pricing less than a one-in-three chance of another rate hike this year, down from about 40% before he spoke.
The interest rate on 10- and 30-year Treasury bonds rose as Powell made his remarks.
In raising the Fed’s benchmark interest rate “the whole idea…is to affect financial conditions,” Powell said. Bond markets “are producing tighter financial conditions right now,” and seemed to be moving for a variety of reasons, such as an upgraded view of the U.S. economy’s strength, independent of any expectations about the Fed.
It is an important distinction, Powell noted. If bond investors were raising long-term bond yields only because they thought the Fed was about to raise its own short-term policy rate, the central bank would have to follow through – or long-term rates would fall.
This appears to be a different dynamic, and one that Powell and several of his colleagues have suggested in recent days could begin substituting a market-driven tightening of credit for changes in the Fed’s short-term federal funds rate.
“Financial conditions are tightening, there’s no getting around that, it moves the needle towards the Fed doing less rather than more…I think we’re at the plateau here,” said Shaun Osborne, chief foreign exchange strategist with Scotiabank.
Powell walked a narrow line in his remarks, leaving open the possible need for more rate hikes because the economy had proved stronger than expected, but also noting emerging risks and a need to move with care.
His comments throw the focus on upcoming data for signs the economy is slowing, the labor market cooling and price pressures continuing to ebb, as U.S. central bankers anticipate, or if, as some analysts suggest, the economy is likely to maintains its strength and inflation show signs of rebounding.
“We are attentive to recent data showing the resilience of economic growth and demand for labor,” Powell said in prepared remarks that were delayed briefly by climate protesters. “Additional evidence of persistently above-trend growth, or that tightness in the labor market is no longer easing, could put further progress on inflation at risk and could warrant further tightening of monetary policy.”
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