(Bloomberg) — Jerome Powell doesn’t like to bless bets in the financial markets, but he…

(Bloomberg) – Jerome Powell doesn’t like to bless financial market bets, but he could move the needle this week to where investors expect the Federal Reserve to raise interest rates to cool overheated prices.

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The Fed chairman and his colleagues want to quickly raise rates to a neutral level this year that neither boosts nor hinders growth – around 2.5% – and then slows the pace of tightening.

But in crises, central banks that take a break typically lose as the forces they are fighting — whether spreading financial panic or widening inflation — gain momentum. .

“You don’t stop halfway” in a fight against inflation, said former Fed Governor Laurence Meyer, who now runs policy analysis firm LH Meyer. “You look around you, but there is an urgency to go beyond” a neutral interest rate.

US central bankers don’t want to trigger a recession and Powell expressed confidence in the Fed’s ability to pull off a soft landing that brings inflation back towards its 2% target without slowing the economy.

But he also prioritized price stability. “If we determine that we need to tighten beyond common neutrality measures and into a more restrictive stance, we will do so,” Powell said March 21.

He publicly backed the tightening of the frontloading policy in remarks on April 21 that helped cement expectations of a half-point hike when officials wrap up their two-day meeting on Wednesday, followed by at least such a big move in June.

Minutes from their March meeting also indicated that the committee would likely agree to begin trimming its $9 trillion balance sheet in May, rapidly ramping up to a peak runoff rate of $95 billion a month.

Having already provided plenty of clues about what to expect, most of the new information will come from Powell’s press conference after the 2:30 p.m. meeting in Washington — his first to be held in person since the pandemic began.

Powell will have just spent two days gauging the mood of his colleagues. If he comes out and signals that the policy may require a more restrictive position – that is, above his neutral framework – that would be a significant change. Market consensus currently shows rates peaking above 3.4%, but this is higher than the Fed’s median forecast that was updated in March.

“The Fed has very little room to underachieve” on the tightening policy, said Ed Al-Hussainy, global rates strategist at Columbia Threadneedle. “They need to say they are willing to risk tipping the economy into recession to signal inflation credibility.”

The March Fed forecast shows five officials forecasting rates above 3% in 2023 and 2024 to bring inflation back towards their target.

That was more hawkish than the median official, who saw rates at 2.8% both years, but it’s plausible that more policymakers joined those ranks given the incoming economic data.

Economists at Deutsche Bank AG say the Fed will need to raise rates much more aggressively – well within the 5% or 6% range – to rein in inflation, leading to a deep recession next year.

First-quarter gross domestic product figures released Thursday showed strong underlying demand, with actual final sales to domestic buyers accelerating at an annual rate of 2.6%.

Capacity utilization is increasing and capital spending is holding up. The employment cost index, an important indicator of total compensation costs observed by Powell, rose 4.5% from the previous year, a gain that should support demand and perhaps support inflationary pressures.

And the job market remains tight. Payrolls rose by 385,000 in April, according to the median estimate from a Bloomberg News survey. The monthly employment report will be published on May 6.

“The recovery continues to be robust,” Visa Inc. Chairman and CEO Alfred Kelly told analysts on April 26. “At this stage in terms of volumes, we have not seen any noticeable impact due to inflation, supply chain issues or the war in Ukraine.”

For central bankers, this is all good news, except for one thing: it has been accompanied by rising inflation rates and an upward drift in some measures of longer-term inflation expectations. .

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The Fed’s preferred price measure rose 6.6% in March, more than three times its target. A University of Michigan survey of expected price change over the next 5-10 years has averaged 3% over the past 12 months versus 2.7% for the last expansion. And a New York Fed survey of three-year inflation expectations averaged 3.6% in the first quarter from 2.9% in the first quarter of 2019.

“Underlying Inflation”

“All the measures tell us that underlying inflation is not where it should be,” said Conrad DeQuadros, senior economic adviser at Brean Capital. “The endpoint they need to get inflation under control will likely have to be ‘tighter than their current estimates of 2.8%.

The Fed’s narrative of caution once it hits rates around 2.5% also reflects its high uncertainty.

Russia’s invasion of Ukraine and China’s series of virus lockdowns could both slow global growth and worsen supply chains, creating more scarcity and higher prices. At the same time, slowing growth in China and Europe could create disinflationary forces.

Anna Wong, chief U.S. economist for Bloomberg Economics, said a drop of just 4% in the level of GDP in China can lead to a 30% reduction in oil and commodity prices, potentially offsetting the effects inflationary effects of Europe’s potential oil embargo. Russia.

An easing in commodity prices could “trick” the committee into pausing as it approaches a key rate of 2.5% later this year, Wong said.

But wage pressures are expected to continue to grow, at least in nominal terms, she said, and support price increases for basic services.

“The path to a soft landing is very narrow,” Wong said, and depends on faster labor force growth to help meet the demand for workers, which may be unlikely. “The Fed will have to keep climbing and cannot afford to stop until it gets closer to 4%.”

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