Fed chair Jerome Powell signals slow, cautious approach to raising rates

Federal Reserve chairman Jerome Powell is signalling he expects the Fed to continue gradually raising interest rates if the U.S. economic expansion remains strong.

Speaking to an annual conference of central bankers in Jackson Hole, Wyo., he said the central bank recognizes it generally needs to strike a balance between being supportive of growth by not raising rates too quickly and being too restrictive, by raising them at a pace that could slow the economy.

Powell said this gradual approach is the wisest policy for the Fed in trying to navigate between the risks of raising rates too quickly and thus "needlessly shortening the expansion," and moving too slowly and risking an overheated economy.

"If the strong growth in income and jobs continues, further gradual increases in the target range for the federal funds rate will likely be appropriate," he said. 

Most observers expect the Fed to raise its benchmark rate again in September, after raising it .25 of a point in March and again in June. It has raised rates seven times since 2015, when it first started tightening after the Great Recession. 

His words reinforcing the Fed's plan to gradually raise rates seemed to have reassured investors.

Both the Dow Jones Industrial Index and the wider S&P index spiked upward at 10 a.m. with his opening remarks. The markets, trading at record levels, continued to rise at midday.

"The equity markets wanted to hear that slow-and-steady is the path, and I didn't hear anything to the contrary," said Rob Eschweiler, global investment specialist at J.P. Morgan Private Bank.

Canada's central banker, Stephen Poloz, is to take part in a panel on Saturday.

Upbeat about U.S. economy

Powell was generally upbeat on the U.S. economy. He pointed to the U.S. unemployment rate, now near a 20-year low at 3.9 per cent, and inflation that  has moved up to near the Fed target of two per cent.

"With solid household and business confidence, healthy levels of job creation, rising incomes and fiscal stimulus arriving, there is good reason to expect that this strong performance will continue."

Powell made no mention of the recent public criticism of the Fed from President Donald Trump, who has said he's unhappy with rate hikes. The president has complained that the Fed's tightening of credit could threaten the continued strong growth he aims to achieve through the tax cuts enacted late last year, a pullback of regulations and a rewriting of trade deals.

The Fed chair also did not mention any potential impact of Trump's trade revamp, which many investors and corporations oppose. But he did point to several structural problems in the U.S. economy that could threaten its continued growth.

The low pace of wage growth is one such problem. Usually when labour markets get tight, wages rise as companies seek out workers — that hasn't happened, particularly for low and middle-income workers, Powell said.

"Economic mobility in the United States has declined and is now lower than in most other advanced economies," he said, adding that the economy has experienced "low productivity" for almost a decade.

Concern about deficit

He also said he was concerned about the U.S. federal budget deficit, which stood at $77 billion US in August after the Trump administration enacted a tax cut. This deficit "has long been on an unsustainable path, becomes increasingly important as a larger share of the population retires," he said.

Most of his speech was devoted to how to weigh economic indicators to strike a balance between tightening rates too quickly or too slowly.

While central bankers tend to focus heavily on controlling inflation rate in determining when rates should rise, Powell said inflation has not behaved as expected in recent years and it was often more prudent to look at multiple other factors in trying to decide when to raise rates.

"In the run-up to the past two recessions, destabilizing excesses appeared mainly in financial markets rather than in inflation. Thus, risk management suggests looking beyond inflation for signs of excesses."

He also said the U.S. natural rate of unemployment may be much lower that the Fed has estimated, as seen by lower GDP growth and a lack of inflationary pressure. Again, he urged a central bank approach that weighed a number of factors.

"One general finding is that no single, simple approach to monetary policy is likely to be appropriate across a broad range of plausible scenarios," he said.

Derek Holt, head of capital market economics at Scotiabank, said Powell's key emphasis seemed to be on his gradual approach to rate hikes.

"It is the symbolism of pointedly rejecting calls to go faster or slower that may be the more important part of the messaging," Holt said in a note to clients.

Powell's remarks about the confusing trends in inflation and unemployment data and the need to watch data from multiple sources show he is not much different from his predecessors in his approach, Holt said.

"All of this seems very sensible to me.  It is the steady hand provided by a chair's stewardship during a period of enormous uncertainty," Holt said.

BMO deputy chief economist Michael Gregory said there is "not much new" in Powell's speech, though it suggests that the Fed may not be as bothered by low inflation as some believe.