Fed chair signals smaller rate hikes as bank keeps up inflation fight

More important, though, will be how much further rates climb next year, and how long it will be necessary to hold them high enough to slash inflation and bring the labor market into sync with the broader economy’s needs.

“It is likely that restoring price stability will require holding policy at a restrictive level for some time,” Powell said. “History cautions strongly against prematurely loosening policy. We will stay the course until the job is done.”

Almost everyone expects a recession. Could the economy avoid one?

The remarks come as financial markets are anxious for any signs that the Fed is ready to ease up on its historic rate hike campaign. Markets were jittery early Wednesday afternoon as investors waited for Powell’s speech, but they quickly flashed green as he spoke. The Dow Jones industrial average closed up 737 points, or 2.2 percent. The S&P 500 was up 3.1 percent, and the Nasdaq rose 4.4 percent.

Powell has said that the Fed’s inflation fight will inflict some pain on households and businesses. But a long-feared recession has yet to arrive, and key pillars of the economy remain remarkably resilient to higher rates. The widely held expectation is that the economy will slow drastically next year, and inflation has brought tremendous uncertainty to every sector. But there is no precedent for this economy after the worst of the pandemic, and Powell’s job is to give some insight into his thinking while acknowledging how confounding the outlook remains.

“The truth is that the path ahead for inflation remains highly uncertain,” Powell said.

Much of the uncertainty stems from the fact that the pandemic has repeatedly thwarted economic models and forecasts. Taking questions after his speech, Powell said he and his colleagues will have to be “humble and skeptical about forecasts for some time” as they manage risks from all sides.

“We have a risk management balance to strike,” he said. “We think slowing down at this point is a good way to balance the risks.”

Powell said that for the Fed to win its inflation fight, production bottlenecks must keep easing, and he acknowledged that they’re already on the right path. Inflation on new leases — a crucial housing market indicator — must continue to fall next year. And the labor market must cool down, with wages falling to more sustainable levels.

“Despite some promising developments, we have a long way to go in restoring price stability,” Powell said.

Powell put particular emphasis on the labor market, which has been transformed by the pandemic in ways economists still struggle to understand. When asked about whether the workforce participation rate could get back to pre-pandemic levels, Powell said few gains had been made this year, adding, “It’s been very disappointing and a little surprising.”

The number of job openings also far exceeds the number of people looking for work, and Powell said that the shortfall in labor supply “appears unlikely to fully close anytime soon.” He specifically pointed to the high number of excess retirements that makes up a bulk of the 3.5 million people missing from the labor force. The Fed cannot bring more people back into the labor market, so its goal is to get borrowing costs high enough that businesses pull back on hiring and investing, thus cooling demand for new workers.

“A [half a percentage] point hike is almost certainly in play at the December meeting,” said Joe Brusuelas, chief economist at RSM. “His point about excess retirements and labor force participation rates is spot on. We are experiencing structural change in the labor market in real time, and policy has to adjust.”

But Powell said it would also be useful if other policymakers — he didn’t name any, but the task could fall to Congress or the Biden administration — help find ways to add workers to the labor force while the Fed focuses on demand for work.

“I will say that policies to support labor force participation could, over time, bring benefits to the workers who join the labor force and support overall economic growth,” Powell said, noting he was not advocating for any particular policies. “For the near term, a moderation of labor demand growth will be required to restore balance to the labor market.”

Plenty of other Fed officials — including board members and regional bank presidents — have weighed in on the economy and the path ahead in recent weeks, especially after an October inflation report came in much better than expected. But Powell has not spoken publicly since the Fed’s last policy meeting in early November, when he warned that it had become “harder to see the path” to avoiding a recession. Some Fed watchers speculate that Powell’s speech Wednesday was meant to reassure markets that while the Fed will slow its hikes, it has not yet regained control of inflation, which remains near 40-year highs despite signs of easing and affects nearly every part of Americans’ daily lives.

Powell is not scheduled to speak again in public until the Fed’s final policy meeting of the year in mid-December. The remarks Wednesday, then, aimed to cement expectations for Wall Street and the broader public about what is still to come. The Fed has enormous power wrapped up in interest rate policy. But the central bank also depends heavily on messaging and communication — and on the chair’s ability to guide markets about what the Fed is doing.

How the Fed’s rate hikes slow the economy — and impact you

That is a difficult job in any time, and especially when the economy is as mystifying as it is today. To fill the gaps, officials will look closely at economic data being released this week. On Wednesday, a government report showed the number of job openings ticked down in October, an encouraging signal for officials looking for signs that the labor market may be slowing. New inflation data covering October comes out Thursday, and the November jobs report comes out Friday.

Still, those snapshots are unlikely to change the Fed’s likely plans to raise rates by half a percentage point in two weeks, marking the seventh rate hike in a historic year.

The central bank increased rates by three-quarters of a percentage point at each of its last four meetings, moving at the most aggressive pace in decades. Since March, the Fed has lifted its policy rate from near zero to between 3.75 and 4 percent, and expectations are growing among Fed watchers and economists that rates could eclipse 5 percent next year. When officials convene in two weeks for their final meeting of the year, they will compile new economic projections likely showing that rates stay higher for longer than previously expected — and that any rate cuts are still well off in the future.

The great mismatch: Remote jobs are in demand, but positions are drying up

That approach is difficult to get right. The Fed does not want to signal that smaller hikes mean officials are seeing enough progress on inflation. And in a similar way, the Fed does not want the markets or Wall Street analysts to misinterpret an eventual pause in rate increases. Hikes operate with a lag, and it will take months for the full weight of the Fed’s decisions to seep through the economy. Sometime in 2023, the Fed’s goal will shift from raising rates to holding them at a sufficiently high level and letting the economy continue to slow — ideally, without contracting altogether.

Speaking to reporters earlier this month, Boston Fed President Susan M. Collins said took issue with the word “pause” to describe what would happen if the central bank stopped raising rates, since it could have misleading associations.

“Getting rates to a level where they’re sufficiently tight, and holding them there, is about resolve, because that does have an impact on the economy,” Collins said. “To me, that’s not a ‘pause.’ ”