Jay Powell has sent his strongest signal yet that the Federal Reserve could start dialling back its massive pandemic-era stimulus programme this year, declaring “clear progress” in the recovery of the US labour market.
In a closely watched virtual speech at the Jackson Hole gathering of central bankers on Friday, Powell said the US central bank had met the first of two goals it wants to achieve before reducing its monthly $120bn asset purchase programme.
It had pledged to maintain that pace of bond buying until it saw “substantial further progress” on its goals of average 2 per cent inflation and maximum employment.
“My view is that the ‘substantial further progress’ test has been met for inflation,” Powell said on Friday. “There has also been clear progress toward maximum employment.”
Minutes from the Federal Open Market Committee’s latest meeting indicated a majority of officials believe it would be appropriate to start “tapering” the bond-buying programme this year — a timeline that Powell endorsed on Friday.
“At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year,” the Fed chair said.
The question of when the Fed would pull back from its bond-buying programme has left investors jittery in recent months as they brace for heightened volatility in financial markets.
Wall Street welcomed Powell’s comments on Friday, with the S&P 500 up 0.7 per cent following his speech. Benchmark 10-year Treasury yields, which underpin borrowing rates across the globe, fell 0.04 percentage points to 1.31 per cent.
The Fed chair’s speech comes at a highly uncertain moment for the world’s largest economy.
Policymakers and economists alike are scrambling to assess the potential economic damage from a surge in Covid-19 cases fuelled by the highly transmissible Delta strain, which abruptly disrupted the Kansas City Fed’s plans to host this year’s symposium in person.
Conflicting economic signals have also made it difficult for central bankers to reach a consensus on when exactly the “tapering” process should begin, and at what point these bond purchases should cease altogether.
A growing cohort of central bank officials have pointed to surging US consumer prices, which have been propelled by widespread supply chain constraints, to build a case that the Fed should end these bond purchases soon if it wants to avoid even higher inflation and financial instability.
Powell has previously acknowledged that inflationary pressures have mounted more quickly and by a larger magnitude than the Fed had initially forecast, and on Friday insisted the central bank would act if needed.
“If sustained higher inflation were to become a serious concern, the Federal Open Market Committee would certainly respond and use our tools to assure that inflation runs at levels that are consistent with our goal,” he said.
However, he warned against moving prematurely to tackle consumer prices, which the Fed believes to be “transitory” and are most pronounced in a narrow range of sectors sensitive to pandemic-related disruptions.
“If a central bank tightens policy in response to factors that turn out to be temporary, the main policy effects are likely to arrive after the need has passed,” he said. “The ill-timed policy move unnecessarily slows hiring and other economic activity and pushes inflation lower than desired. Today, with substantial slack remaining in the labour market and the pandemic continuing, such a mistake could be particularly harmful.”
His comments come as more “hawkish” members of the policymaking FOMC call for an announcement on tapering at the Fed’s September meeting. They have argued for an end to the programme by the second half of next year at the latest.
That would give the Fed the flexibility it needs to raise US interest rates in 2022 if inflation proves more persistent than initially anticipated. The Fed’s latest projections, published in June, indicate that at least two rate increases are expected in 2023.
But with almost 6m more Americans out of work than before the pandemic struck, and Covid concerns rising again, another faction of officials have argued that a more patient approach may still be appropriate.
Most market participants believe an announcement is likely in November, with tapering beginning either in December or January.
Powell also sought to assure investors that the Fed would not move immediately to substantially tighten monetary policy as it takes its first steps to reduce stimulus.
“Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions,” he said.
Tom Graff, head of fixed income at Brown Advisory, said: “I think he has crafted this speech to detach tapering from any other policy move.”
“He has to walk this fine line between acknowledging that inflation is there, but also explain why this is actually more of a micro step not implying any steps beyond that”.
The decoupling of a taper from future rate rises helped explain the muted market reaction to the speech, market participants said. The two-year Treasury yield, which is sensitive to monetary policy adjustments, dipped 0.03 percentage points to 0.22 per cent.
Additional reporting by Joe Rennison in New York