Fed Chair Jerome Powell speaks Monday. (Photo by Valerie Plesch/Bloomberg via Getty Images)
One way or another, the Federal Reserve is determined to bring the demand side of the economy into line with supply. That was the underlying message of a speech chair Jerome Powell gave Monday.
Why it matters: For the last two years, the Fed has made policy on the assumption that supply-side problems caused by the pandemic were temporary, and so policy should look through them. No more.
- Either the supply constraints that are holding back economic activity ease, or the Fed will keep tightening monetary policy to crush demand to get it into line with that limited supply.
Between the lines: The optics of Powell's speech were intriguing. He struck a tone notably more hawkish than he did just five days earlier when the Fed raised its interest rates. Nothing much had changed in terms of markets or economic data between Wednesday and Monday.
- This is an example of what we've called the Powell Ratchet — his strategy of steadily pushing toward tighter policy, taking just enough time in between each action to assess the reaction and allow markets to adjust.
The details: Powell still hopes that the supply side of the economy will complete a long-awaited bounce-back in the coming months, with workers rejoining the labor force and supply snarls un-snarling.
- Yes, but: "In the meantime, as we set policy, we will be looking to actual progress on these issues and not assuming significant near-term supply-side relief," he said.
- And while normally an upward shock to commodity prices like the one caused by the war in Ukraine, would be the kind of thing the Fed would look past, Powell said Monday that "the risk is rising that an extended period of high inflation could push longer-term expectations uncomfortably higher," underscoring the need to move "expeditiously."
By the numbers: Markets got the message. Futures markets priced in a 63% chance the federal funds rate will be 2.25% or higher at the end of the year Monday, up from 30% Friday.
The bottom line: The Fed has moved slowly to this point in its fight against inflation. Powell's speech was a notice that things have changed.