Source: Tradingview

In his initial statement, Jerome Powell acknowledged the challenges of bringing sticky inflation down to the Fed’s target of 2%, reinforcing recent concerns among economists that it might take years to get there. According to J. Powell a higher-for-longer approach is deemed necessary, as the path back to target inflation could prove to be longer than hoped, especially if there is no softening in the labour market conditions.

The latest economic data from the U.S. have been stronger than expected. In his speech the Fed chair addressed the tight labour market, the solid consumer spending and manufacturing production, and the higher-than-expected inflation data. Mr. Powell warned that if these strong data trends persist, the Fed could speed up its rate increases.

In prepared remarks to the Senate Banking Committee the Fed Chair mentioned that so far there is little sign of disinflation in the category of core services excluding housing, which accounts for more than half of core consumer expenditures. In order to restore price stability, the Fed needs to see lower inflation in this sector.

Investors are trying to figure out how high the Federal Reserve will hike interest rates later this month, how far the terminal rate would rise and when the Fed is likely to pivot away from its painful and aggressive monetary tightening policy.

After Powell’s comments, investors dramatically raised their bets of a 50-basis-point rate hike in March, with money market futures showing 75% chance of such a move, from 30% a week earlier. Meanwhile, Fed fund rates were seen peaking at 5.6% in September compared to 5.47% earlier.

Overall, in the absence of a disappointing February Nonfarm report this Friday, there is a high probability the Fed would deliver a 50-basis point hike in March, followed by two additional 25-basis point hikes in May and June.

Powell’s hawkish tone came after the U.S. central bank has been reducing the size of rate rises for months, from a peak of 75-basis point, which was sustained from June to November. In December, the rate hikes were scaled back further to 50-basis point and then revised down again in February to the more typical 25-basis point increase.

At present the Fed’s main interest rate is at a target range between 4.5% and 4.75%, in comparison to near zero in early 2022. In December, the Fed projected interest rates would reach a peak of 5.1% in 2023, but Tuesday’s comments from Jerome Powell indicate that he is open to increase the pace of hikes again in the face of unexpectedly persistent price pressures.

There are two critical data releases which are due before the next Fed’s meeting on the 22nd of March – the Nonfarm Payroll report this Friday and the CPI report for February due next week. These reports will be closely watched as they are seen as influential on the Fed’s decision.