Fed’s Jerome Powell Says Data Will Determine Size of Next Rate Increase

February reports on hiring, inflation will guide rate decision, central bank chair says in testimony

Federal Reserve Chair Jerome Powell said Wednesday (08.03.2023) officials were keeping their options open over how much to raise interest rates this month after investors interpreted his comments Tuesday to suggest a half-percentage-point increase was likely.

His comments over two days of congressional hearings show how the central bank is contemplating a shift in tactics to keep up with an economy showing surprising strength after a year of rate increases.

Mr. Powell said government reports on hiring and inflation in February, due for release over the coming week, would shape the outcome of the March 21-22 meeting.

“I stress that no decision has been made on this,” Mr. Powell told the House Financial Services Committee. He inserted those words ad lib into his opening remarks that were otherwise identical to testimony delivered Tuesday in the Senate, when he said officials were prepared to make a larger rate increase if warranted by “the totality of the data.”

His comments indicated Fed officials will debate whether to raise rates by a quarter-point, as they did last month, or by a larger half-point, as they did in December.

They raised their benchmark federal-funds rate to a range between 4.5% and 4.75% last month, their latest increase aimed at fighting inflation by slowing the economy. They slowed the pace of rate increases at their past two meetings after lifting them by 0.75-point at four consecutive gatherings last year.

Officials have spent the past 2½ months highlighting the benefit of slowing rate rises so they can better evaluate the impact of their past moves and explaining why the ultimate level of interest rates was more important than the magnitude of increase at a given meeting. They have used quarterly interest-rate projections—which will be updated at their meeting in two weeks—to guide investors about their near-term intentions.

That had convinced many investors that the Fed had settled on a strategy of raising rates in quarter-point increments until officials saw enough evidence that the economy was slowing for them to suspend rate rises. So when Mr. Powell signaled a half-point rate rise was in play on Tuesday, it led to a significant shift in market expectations.

Mr. Powell opened the door to a larger rate increase this week after several economic reports revealed hiring, spending and inflation were hotter in January than expected. Equally important, data revisions showed inflation and labor demand didn’t soften as much as initially reported late last year.

Employers added 517,000 jobs in January, a surge that shocked economists who were anticipating hiring to slow. The Labor Department is set to report on February hiring this Friday.

Meanwhile, inflation’s decline late last year stalled in January. The 12-month inflation rate, excluding volatile food and energy items, was 4.7%, up from 4.6% in December, as measured by the Commerce Department’s personal-consumption expenditures price index.

The data surprised the Fed, which has been trying to curb investment, spending and hiring by raising rates, which makes it more expensive to borrow and can push down the price of assets such as stocks and real estate. The fed-funds rate influences other borrowing costs throughout the economy.

The economy’s seemingly muted response, so far, to the Fed’s aggressive rate increases last year reflect unusual dynamics resulting from the pandemic and the government’s policy response. “Today’s economy is no longer as interest-rate sensitive as that of past decades, and its resilience, while a virtue, does complicate matters for the Fed,” said Rick Rieder, BlackRock Inc.’s chief investment officer of global fixed income.

Market expectations of a half-point, or 50-basis-point, Fed rate increase edged higher Wednesday after Mr. Powell’s remarks and after a government report showed job openings remained high in January.

“The threshold for them to not do 50 is very high given the way the data is coming in,” said Diane Swonk, chief economist at KPMG. “So far, all the data continues to be on the side of 50.”

Mr. Powell could face a tricky task forging consensus among the 18 policy makers who participate in Fed rate-setting meetings. A shift to a bigger rate rise could lead to pushback from some officials who had grown uneasy raising rates in larger increments and could create confusion over the central bank’s strategy.

“This is about creating optionality,” said Ms. Swonk. While it could be embarrassing for the central bank to accelerate rate rises just after slowing them, “it’s more humiliating to get the overall policy wrong. It’s important if you say you’re data dependent to change your priors.”

Mr. Powell repeated Wednesday that Fed officials were likely to lift rates higher this year than previously expected to bring inflation under control. In December, most of them thought they would raise their benchmark federal-funds rate this year to between 5% and 5.5% and hold it there into 2024.

Several forecasters now expect the Fed to project rates may rise to around 5.75% this year. The job market’s strength and signs of more persistent inflation create “a reasonable chance that the Fed will have to bring the fed-funds rate to 6%, and then keep it there for an extended period to slow the economy and get inflation down to near 2%,” Mr. Rieder said.

The Fed last increased rates to 5.25% in 2006, and rates haven’t been above that level since 2001.

If the Fed raises the fed-funds rate closer to 6%, the odds of a more severe downturn rise “quite dramatically,” said Ms. Swonk.

While the risk of a recession in an election year could cause heartburn for Democrats as President Biden prepares to run for re-election, Mr. Powell heard few complaints from lawmakers over two days of congressional testimony, suggesting little political resistance for now.

“Even though rates have moved up significantly over the past year, most members signaled support for Chair Powell continuing to fight inflation, and few criticized him,” said Andrew Olmem, a partner at Mayer Brown and former chief counsel for Republicans on the Senate Banking Committee.