Powell signals hawkish Fed is flying blind

Reuters

5 hours ago

ORLANDO, Florida, June 19 (Reuters) - The Federal Reserve took a slightly hawkish turn on Wednesday, indicating it is worried more about rising inflation than slowing growth. But Chair Jerome Powell suggested this outlook should be taken with a large grain of salt.
The Fed's revised economic projections show that officials expect U.S. unemployment and inflation to rise and growth to slow in the coming quarters. 'Stagflationary' risks are rising.
Yet unlike most other G10 central banks, the Fed is refusing to cut rates preemptively, opting instead to wait for more clarity about the tariff-fueled inflation outlook before deciding on its next step.
This is understandable. The full effects of President Donald Trump's tariffs on prices and economic activity will only be felt after July 9, when the current pause on so-called "reciprocal" tariffs ends. Meanwhile, new geopolitical risks are rising as the escalating war between Israel and Iran pushes oil prices higher.
Given this backdrop, keeping policy "modestly" restrictive, as Powell described the Fed's current stance, is reasonable.
But even though the economy and labor market are still "solid" in his opinion, the growth outlook is deteriorating just as rapidly as the inflation outlook.
Fed officials' projections anticipate that cumulative GDP growth over 2025-2027 will be around 1.25 percentage points lower than forecast in December, and cumulative inflation will be roughly a percentage point higher.
If growth and inflation risks are roughly balanced, why did officials trim their interest rate cut projections for the next two years by a quarter point, or put another way, why do they envisage a higher "terminal" rate?
This hawkish tilt may primarily be about controlling sentiment. A central bank's number one job is keeping inflation expectations anchored, and some recent surveys show consumers' expectations for price increases have soared to the highest level in decades.
However, there may be other possible motivations for maintaining this hawkish stance.
First, the Fed missed the inflation surge of 2021-22, stating infamously that price increases would be "transitory". Policymakers were stung by the criticism that followed. Whether those critiques were warranted is debatable, as no major central bank got this call right, but, regardless, the Fed won't want to risk repeating that mistake.
Then there are America's ballooning fiscal and institutional risks. The combination of persistent budget deficits, a rising debt load, a budget-busting tax and spending bill and ebbing global faith in the dollar and U.S. assets is keeping long-term Treasury yields elevated. This may warrant a higher long-term policy rate too.
And finally, there are Trump's repeated verbal attacks on the Fed, and Powell in particular, for not lowering rates. This public criticism could actually be backfiring by prompting an equally public display of independence by the Fed to dispel any question of political interference.
Powell would almost certainly play down these motivations or dismiss them outright, but they will nonetheless continue to affect how investors interpret the Fed's actions.
Ultimately, the most important factor influencing the Fed right now is likely the simple fact that it has no idea what is coming down the pike.
"The level of uncertainty around economic policymaking right now is sky-high. Other countries aren't experiencing this in the same way. The U.S. is very unique," says Mike Konczal of Economic Security Project.
Powell simply wants to wait and see how the landscape looks once Trump's tariffs are settled and implemented. Erring on the side of inaction in this environment – especially when the economy still appears reasonably healthy – makes some sense.
But this also raises questions about the usefulness of the Fed's "dot plot", a visual representation of all 19 Fed officials' year-end rate projections. For example, what is an investor to make of the fact that the median forecast for 50 basis points of easing this year was unchanged but seven officials voted for no cuts at all?
"No one holds these rate paths with a great deal of conviction," Powell told reporters on Wednesday. "Think of it as the least unlikely path in a situation like this where uncertainty is very high."
That appears to be Fed-speak for "We have no idea what's happening. Check back in with us in a few months."
The Fed next revises its economic projections in September, by which time there should be more visibility around tariffs, Middle East tensions and the U.S. fiscal outlook. Until then, Powell and company will have to sit tight and watch as everything plays out – just like the rest of us.
(The opinions expressed here are those of the author, a columnist for Reuters)
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