In a highly anticipated speech, Federal Reserve Chair Jerome Powell acknowledged that the strong U.S. economy may require further interest rate increases. He pointed out that the economy has exceeded expectations, with robust consumer spending that could contribute to higher inflation pressures. Powell emphasized the Fed’s commitment to maintaining an elevated key rate until inflation is brought down to the central bank’s target of 2%. He stated, “We are prepared to raise rates further if needed and will continue with a restrictive policy until we are confident that inflation is declining sustainably.”
Despite Powell’s speech, the stock market held onto gains, with the S&P 500 rising 0.4% and the Dow and Nasdaq composite also showing positive numbers. This was a contrast to Powell’s remarks at last year’s Jackson Hole conference, where he issued a clear warning to Wall Street about the need for rate hikes.
Morgan Stanley analysts described Powell’s speech as a message of patience, indicating that the Fed will closely monitor incoming data before making any decisions regarding rate hikes. The report stated that the Fed views its current rate as sufficiently high to restrain the economy. However, Powell acknowledged the uncertainty surrounding the effectiveness of the Fed’s policies in reducing inflation.
Since Powell’s last speech at Jackson Hole, the Fed has raised its benchmark rate to a 22-year high of 5.4%. Inflation has declined from its peak of 9.1% in June 2022 to 3.2%, although still above the target. Powell welcomed this decline in inflation but emphasized the need for further rate increases to ensure sustainable progress.
The rate hikes have resulted in higher loan rates, making it more challenging for Americans to afford homes or cars, and for businesses to fund expansions. However, prices for essential services continue to rise. Powell mentioned that “core” inflation, excluding food and energy prices, remains elevated despite the Fed’s previous rate hikes.
Despite concerns about the impact of rate hikes, the overall economy has remained strong. Hiring remains healthy, consumer spending continues to grow, and the unemployment rate remains low at 3.5%. The Fed’s quarterly projections, released in June, initially suggested one more rate hike this year. However, the recent milder inflation readings may affect these projections, which will be updated during the September 19-20 meeting.
Optimism about a “soft landing” for the economy has increased, with many economists revising their predictions for a recession. This positive outlook has driven a surge in bond yields, particularly the 10-year Treasury note, impacting long-term mortgage rates.
Some economists believe that the higher long-term rates could reduce the need for further Fed rate hikes, as they may slow growth and help to alleviate inflation pressures. As a result, they anticipate that the July rate increase may be the last one for the foreseeable future.
However, keeping the benchmark rate elevated could pose risks to the economy, potentially triggering a downturn and affecting banks with reduced bond values. Despite these concerns, the ongoing strength of the economy suggests that growth is sustainable, and there is a possibility that the post-pandemic economy has transitioned into a higher gear, capable of expanding despite elevated borrowing costs.
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