Powell’s Dilemma: Damned If You Do, Damned If You Don’t

Congress expects Powell to fight inflation,
but to do that he has to raise interest rates which will tank the stock market.

Time to fire up the FED’s trusty rhetoric machine to keep everyone happy.

At a time when markets anticipate the Fed to do less, Federal Reserve Chairman Jerome Powell is expected to tell Congress this week that the central bank will do more to manage inflation.

Fears of a Russian invasion of Ukraine have caused financial markets to tremble, and Wall Street has discreetly lowered its expectations for Fed action.

Markets had expected the Fed to hike interest rates seven times in 2022, but current pricing suggests just five movements. This would imply raising the Federal Reserve’s benchmark short-term borrowing rate by around 125 basis points, to a range of 1.25 percent to 1.5 percent.

Powell will have to walk a tightrope as he testifies before Congress during two days of hearing that his institution is devoted to managing inflation while also keeping an eye on global turbulence.

“He’ll have to thread a very fine needle. It’ll be a difficult balancing act,” said Mark Zandi, chief economist of Moody’s Analytics. “My impression is that he starts with the uncertainty that this all generates, given that the Russian invasion may go in a variety of directions, each one worse than the last. He’ll emphasize that in such a tumultuous era, it could make sense for the Fed to be a bit more careful in implementing policy.”

Markets had been anticipating 25 basis point rises from the governing Federal Open Market Committee at each of its remaining seven sessions this year until about a week ago. At the March 15-16 meeting, there was even a significant tendency toward the initial step being 50 basis points.

At least for the time being,  it would seem that Russia’s invasion has taken that option off the table.

“His best message would be to play it by ear,” Peter Boockvar, chief investment officer at Bleakley Advisory Group, says that Powell’s best move would be to tell everyone that he will “play it by ear.” Boockvar thinks this will let him escape the difficult position he finds himself in right now, while using the Russian invasion as an excuse to see where the economy goes from here, before they will buckle down and deal with inflation.

After all, the can has been kicked down the road for years now… what difference will waiting a couple months longer make?

Economists forecast robust growth this year, but a little lower than in 2021, which was the greatest since 1984. In December, Fed policymakers predicted that GDP would grow at a 4% annual rate in 2022.

However, the Fed’s policy outlook is complicated by persistent inflation, which is at its highest level in 40 years, as well as the possibility that the Russia-Ukraine scenario would add to inflation and further disrupt supply chains.

“We’re approaching a stagflationary moment,” Boockvar added, alluding to high inflation and slow growth. “The issue is whether [Powell] is more concerned with the’stag’ or the ‘flation’?”

The Fed has largely focused on growth after the Volcker style era of handling monetary policy.

Other Economists Aren’t So Sure

Goldman Sachs said in a letter to clients on Sunday that this year’s “quite strong inflation” “should create an easy case” for seven rate rises.

The market has been a bit too quick to price-out the potential for a 50 [basis point] hike at this month’s FOMC meeting, according to Citigroup economist Andrew Hollenhorst on Tuesday.

Nonetheless, according to the CME Group, as of Tuesday midday, the market had fully discounted a half-percentage-point increase and had given a small chance to no movement at all.

Because futures pricing is variable, the odds of a reversal might occur if inflation slows or the Ukraine issue is addressed.

Powell will have to confront a wide variety of opinions on where the Fed should be at a key moment for monetary policy when he delivers his obligatory semiannual briefing before a House panel on Wednesday and then to a Senate committee on Thursday.

“We believe Powell will stress that, despite increased geopolitical uncertainty, the Fed remains focused on its macro objectives and will continue to move forward with policy normalization with the goal of bringing inflation back to target while maintaining employment,” says Krishna Guha, Evercore ISI’s head of central bank policy strategy.

“We believe he will recognize that the Russia-Ukraine conflict, with its stagflationary push from higher energy prices (inflation higher, growth lower), presents new policy concerns,” Guha said.

Regardless of the outcome, both sides expect Powell to take action.

But any course of action he takes will come with significant risks.

Delaying and hoping for things to cool off is his most likely move.