Federal Reserve chief Jerome Powell said Wednesday that he'll back a quarter-point interest-rate hike at the March 15-16 monetary policy committee meeting, despite the impact of Russia's Ukraine invasion, the big new wild card in the outlook. The stock market rallied as Powell testified.
"The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain," Powell told lawmakers in prepared testimony. "We will need to be nimble in responding to incoming data and the evolving outlook."
In answering questions, Powell was clear in that he would support a quarter-point rate-hike this month, not a half-point.
With inflation already running so hot and the Fed so far behind the curve, there's concern on Wall Street that policymakers may feel little choice to not only plow ahead with rapid tightening, but potentially step up the pace of interest-rate hikes. It's not clear how much Powell's testimony will assuage that concern.
Asked whether the spike in energy prices and other effects of the Ukraine war could change the Fed's rate-hiking trajectory this year, Powell said, "I don't think that's knowable yet."
He said there are potential outcomes that might have an impact. "We will use our tools to add to financial stability," taking care not to contribute to uncertainty, Powell assured.
Still, the effects of the war — surging commodities prices and a stock market correction — haven't notably changed Powell's tune. His testimony makes no mention of lower asset prices, while acknowledging "the risk of potential further upward pressure on inflation expectations and inflation itself."
Beyond the March meeting, Powell said the Fed could hike its key rate a half-point at a future meeting, if inflation continues to exceed the Fed's expectations.
Powell's comments illustrated the difficult tightrope the Fed faces. The generational high in inflation stems from "elevated demand in the face of supply contraints," he explained. He added that the Fed's tools can only address demand, not supply constraints, and that's what it plans to do, by moving away from unusually stimulative policy settings.
Beyond rate hikes, Powell reiterated, "Reducing our balance sheet will commence after the process of raising interest rates has begun."
Stock Market, Treasury Yield Action
Higher risk of disruption of key commodity supplies, following an escalation of sanctions on Russia over the weekend, triggered another leg down for the stock market on Monday and Tuesday. On Wednesday, crude oil futures rose nearly 7% to $110.60 a barrel, topping $112 intraday.
Still, major stock market indexes bounced. The Dow Jones climbed 1.8%, the S&P 500 1.9% and the Nasdaq 1.6%. Reports of a new round of Russia-Ukraine talks also helped buoy markets.
On Tuesday, the Dow Jones industrial average closed 9.5% off its record closing high. The S&P 500 is 10.2% below its record close, while the Nasdaq is down 15.7% from its peak.
After tumbling on Tuesday, Treasury yields bounced on Wednesday. The 10-year Treasury yield was up 16 basis points to 1.87%, while the 2-year yield leap 22 basis points to 1.53%.
The CME Group's FedWatch page currently shows nearly 100% odds of a quarter-point hike at this month's Fed meeting.
Wall Street currently sees above-even odds of six quarter-point rate hikes in 2022, lifting the Fed's key rate to a range of 1.5%-1.75%. On top of that, the Fed has laid the groundwork for a partial reversal of its $4.5 trillion in Covid-era asset purchases.
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Federal Reserve Reaction: Ukraine Vs. Omicron
Vladimir Putin's invasion of Russia is just the latest recent inflationary curveball for the Fed, following the delta and omicron variants. Yet the variants were fundamentally different. While reining in economic growth by slowing the services-sector recovery, they also fueled wage growth by shrinking the pool of potential workers, via early retirements, a spate of absences and childcare complications.
This latest crisis, from an economic standpoint, is all about price increases that will slow growth to some extent by reducing spending power and potentially eroding demand. In that sense, it's more of an unalloyed negative that the Fed might normally wait out. But if wage growth continues to remain red-hot, Fed policymakers could decide that they don't have the luxury of patience.
"The Fed tends to look past higher food and energy prices driven by geopolitical events and would, in our view, only be compelled to hike more aggressively if it sees signs of a wage-price spiral, which is not the case right now," Solita Marcelli, chief investment officer in the Americas at UBS Global Wealth Management, wrote Monday.
Powell's emphasis on the tight labor market may shape Wall Street's reaction to Friday's jobs report.
Economists expect Friday's jobs report to show the addition of 390,000 jobs in February, as the unemployment rate eased back to 3.9%, after rising to 4% in January.
However, there's one thing in the jobs report that might be really good news for markets: a surge in labor force participation as the pandemic recedes.
