What would the Chairman of the Federal Reserve say?, Forward looking Powell Congressional Hearing: Banks Suspending Interest Rate hikes | Report | Powell

This week, Federal Reserve Chairman Powell will appear in both houses of Congress to testify on the semi annual monetary policy report.

A week ago, the Federal Reserve suspended its most aggressive tightening policy in nearly 40 years, and the outside world hoped to seek more clues on potential monetary policy paths through hearings.

For the Federal Reserve, there are still variables in its next actions as it needs to assess the impact of monetary policy on the economy. The positions of lawmakers from both parties are expected to continue to clash, and Democrats may acknowledge the Federal Reserve's decision and remind that excessive interest rate hikes could lead to millions of Americans losing their jobs. Republicans may emphasize the view that inflation remains too high, which will put pressure on households and small businesses. In addition, both sides may simultaneously pressure Powell to provide more details on future financial regulation from the Federal Reserve after the regional banking bankruptcy crisis.

Conditions for future interest rate hikes

After the announcement of last week's resolution statement, there were many doubts as to why the Federal Reserve would expect two more rate hikes this year, despite the suspension of tightening? Now, federal funds rate futures are pricing for the July rate hike, so Powell may face the question of what are the conditions for the next rate hike?

The price trend is a key basis for the Federal Reserve to determine its policy stance. The semi annual monetary policy report states that although inflation has eased somewhat, the overall level has remained far above the target of 2% since the middle of last year.

According to the recently released inflation report, the personal consumption expenditure index in the United States increased by 4.4% year-on-year in April, lower than the peak of 7.0% reached in June last year. The core PCE that the Federal Reserve values more has also fallen from its previous high to 4.7%. In addition, the May Consumer Price Index announced last week has already hit a two-year low of 4%.

From the perspective of sub indicators, with the easing of supply chain bottlenecks, commodity prices have continued to decline recently. In terms of core service prices, inflation in the housing service industry has always been the main driver, but there have been signs of a slowdown in the growth rate of rental projects in recent months, and it is expected to further cool down in the second half of the year. In contrast, price inflation in the service industry is still rising and shows no signs of easing.

US inflation has significantly cooled from last year's high

The Federal Reserve remains highly concerned about inflation risks. In the latest statement after the interest rate meeting, Federal Reserve Director Waller stated that further tightening may be needed to reduce core inflation. Richmond Fed Chairman Barkin believes that stubborn inflation may require more interest rate hikes, and a slowdown in demand will allow inflation to recover relatively quickly to its predetermined target.

Compared to the caution of the Federal Reserve, market inflation expectations are continuing to cool. The May consumer survey by the New York Federal Reserve showed that one-year inflation expectations decreased by 0.3 percentage points to 4.1%, a new low since May 2021. In the University of Michigan consumer survey, inflation expectations dropped to 3.3% in June.

Can the job market avoid fluctuations

The monetary policy report states that the labor market remains very tight, with an average of 314000 new non-agricultural jobs added in the first five months, and the unemployment rate remaining near historical lows. Labor demand has eased in many areas of the economy, but supply remains insufficient and job vacancies are still increasing. The Federal Reserve believes that bringing inflation back to 2% may require a period of low trend growth and a softening of labor market conditions.

Behind the continuous interest rate hikes by the Federal Reserve, the correction of wage growth under labor imbalance is also the main reason. The JOLTS report shows that job vacancies in the United States rebounded to 10.1 million in April, with 1.8 job vacancies per available workforce, far higher than the pre pandemic level of 1.2.

Montreal Bank Senior Economist Guatieri said in an interview with First Financial reporters that US companies are still actively recruiting, which may make consumer demand more flexible. "Service inflation has a significant impact on monetary policy, and what the Federal Reserve most hopes to see is a cooling of wages and a decline in service inflation due to a slowdown in labor demand."

After the US non farm payroll exceeded expectations in May, the job market has achieved growth for 29 consecutive months, and the strong demand for labor confirms the resilience of the US economy. However, the lagging effect of tightening monetary policy in the future may bring uncertainty to the cooling effect on the economy.

Goldman Sachs CEO Solomon recently stated that even if the United States does not fall into recession, it is expected to be in a growth environment of 0-1% and an inflation environment of 3.5% -4% this year. Although Goldman Sachs has once again reduced the likelihood of an economic recession, it is now a time for caution. Solomon believes that inflation is "a bit tricky", meaning that future interest rates may rise, which could make the economic environment more challenging. A relatively low unemployment rate is very important, with some signs of economic slowdown, but overall it remains healthy.

From a historical perspective, economic downturns have often been accompanied by short-term large-scale unemployment. In the past two weeks, the number of initial jobless claims in the United States has risen to over 260000, seen as a preliminary sign of labor weakness. For Democrats, the pressure from next year's election may make the job market their top priority, thus putting pressure on the Federal Reserve Chairman to remain cautious on further tightening issues.

Follow up to the banking crisis

The Federal Reserve warned in its policy report that the tightening of credit conditions in the United States after a series of bank failures in the spring may hinder economic growth this year. "There is evidence that the pressure on the banking industry, as well as concerns about deposit outflows and financing costs, have led to tightening loan standards and terms for some banks, exceeding the levels reported before the banking crisis."

According to a credit survey of financial institutions previously released by the Federal Reserve, the proportion of banks tightening commercial and industrial loan terms for large and medium-sized enterprises increased from 44.8% in the fourth quarter of 2022 to 46% in the first quarter. The survey also pointed out a sharp slowdown in credit demand. In the first three months of this year, the proportion of banks reporting strong demand for commercial and industrial loans decreased by 55.5%, the largest decline since the global financial crisis in 2009.

Federal Reserve Chairman Powell stated at a press conference last week that credit tightening may affect economic growth this year. "The economy is facing adverse effects of tightening credit conditions for households and businesses, which could affect economic activity, employment, and inflation, but the extent is still uncertain."

Commercial and industrial loans continue to decline, and the tightening effect of credit may impact the economy

The latest data shows that the amount of borrowing from the Federal Reserve by the US banking industry has risen for the sixth consecutive week and remained above $100 billion, indicating that the financial system is still under sustained pressure. Before the bankruptcy of Silicon Valley Bank, the traditional discount window used $15 billion per week. Meanwhile, in the week ending June 7th, Federal Reserve loans experienced their first decline in nearly a month. The total loan amount fell by $49 billion month on month to $12.09 trillion. It is worth noting that as an economic driving factor, commercial and industrial loans continued to decrease by $13 billion to $2.76 trillion.

Institutions are closely monitoring changes in loan standards and financial conditions. Guartieri told First Financial that he expects the Federal Reserve to be unable to achieve a soft landing, and the main reason for a mild recession in the US economy by the end of the year is the tightening of credit standards, which will become more apparent in the coming months.

Regulatory issues related to the banking crisis are expected to become a focus of attention for lawmakers. The implementation of subsequent regulatory policies, how to effectively prevent a new round of crisis, and the situation of this year's stress test may become the questions that Powell needs to face.