The Market Is Ready To Move On. The Fed Clearly Isn’t.

(Bloomberg Opinion) -- Federal Reserve Chair Jerome Powell wants everyone to know that he’s in the inflation fight for the long haul no matter how much investors seem to be over it. 

That’s the takeaway from Wednesday’s monetary policy decision, in which the Fed’s rate-setting committee lifted its target range by 50 basis points to 4.25% to 4.5%, and Powell pledged to forge ahead in an effort he said would “take some time.” 

Critical to understanding the reaction is an appreciation for the setup. The rate increase had been telegraphed, and so had the Fed’s plan to keep rates higher, but hope had begun to seep back into the market that something might be changing. A day earlier, stocks and bonds rallied after a consumer price index report showed that core inflation rose just 0.2%, the second encouraging report in as many months. Markets were ready to move on, but the Fed wasn’t, as was clear in every development Wednesday. Predictably, the S&P 500 Index tumbled 0.6%, essentially wiping out its gains after the encouraging CPI.

The Statement: From the outset, the Fed made clear how little its outlook had changed. If it had wanted to convey a change, it would have done so in its policy statement released at 2 p.m. along with the decision. It spoke volumes that the committee tweaked almost nothing from its November statement.(1)Critically, the statement retained the following key phrase: “The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”

The Summary of Economic Projections:  But what policy is “sufficiently restrictive” enough to achieve durable disinflation? The committee apparently hasn’t changed its view on that matter. Similar to projections from September, the median economic forecast submitted by Fed board members and presidents implies the goal of getting the Fed funds rate to a level that’s about 1.6 percentage points above the rate of forecast core inflation for both 2023 and 2024. The nominal fed funds projections moved up, but primarily as a reflection of the slightly increased inflation expectations as compared with September.(2)

The Press Conference: Finally, Powell used his remarks to drive home just how little his view had shifted in the face of one new inflation report. “It will take substantially more evidence to give confidence that inflation is on a sustained downward path,” he said.

While Powell acknowledged that he thought the Fed was getting “close” to the policy level deemed sufficiently restrictive, he emphasized the need to keep it high for a sustained period. He also highlighted the persistence of core services inflation excluding housing.(3) As he said at his Brookings Institution speech last month, Powell believes that category of prices will be pushed higher by upward pressure on wages. In Powell’s words:

We see goods prices coming down. We understand what will happen with housing services, but the big story will really be the rest of it, and there’s not much progress there. And that’s going to take some time.

The last inflation report had some preliminary good news about core services excluding housing, but the three-month moving average still implies annualized inflation in that category of around 5.4%, well above the level that’s consistent with the Fed’s target.

It’s conceivable that Powell is more optimistic than he’s letting on. Market rallies often work at cross purposes to the Fed’s goal of keeping financial conditions tight (mortgage rates drop, corporate borrowing costs decline, etc.) But Powell can’t lie to households and the market outright, either, and expect to retain credibility. On Wednesday, he struck a reasonable balance and opted for a message of consistency against the backdrop of a fickle market that was ready to change course without him.

More From Bloomberg Opinion:

• The Fed Should Still Try to Keep Inflation at 2%: Tyler Cowen
• Don’t Get Too Excited Over One Inflation Report: John Authers
• It’s Still Too Soon for the Fed to Relax on Inflation: Editorial 

(1) The only tweaked sentence was edited thusly: "The war and related events are creating additional contributing to upward pressure on inflation and are weighing on global economic activity."

(2) There were some questions as to whether these forecasts might be stale because committee members typically submit their estimates ahead of the meeting, which began Tuesday (the same day as the welcome CPI surprise). But Powell pushed back against this notion, noting that participants were welcome to change their projections in the past two days. “As just a matter of practice, the SEP reflects any data that comes out during the meeting,” he said Wednesday.

(3) Shelter inflation has been persistent, too, but Powell has correctly noted that measures of new market rents are declining. That should be a leading indicator of eventual improvement in the CPI shelter component as well.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company's Miami bureau chief. He is a CFA charterholder.

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