The Fed Chairman, Jerome Powell gave his semi-annual two-day testimony to the U.S. Congress last week. In his testimony, Powell defended the central bank’s monetary policy actions and urged patience in its approach to interest rate hikes.
He delivered a positive assessment of the U.S. economy but struck a cautious tone regarding potential risks.
Speaking to members, Powell said that amid muted pressures of inflation and volatility in the financial markets, global growth remained uncertain. He claimed that the partial government shutdown which was the longest in U.S. history might have also contributed to growth risks.
“When I say we’re going to be patient, what that really means is, we’re in no rush to make a judgment about changes in policy,” Powell told U.S. lawmakers last week.
The Fed raised interest rates 4 times in 2018, once each quarter. In January, the FOMC voted unanimously to keep interest rates steady. Following the meeting, officials said they would remain patient in the timing of future rate hikes. The decision to leave interest rates unchanged came amid inflation slowing. It also came as a result of U.S. President Trump putting pressure on the central bank.
The current stance of the Federal Reserve has left some wondering what the next policy move could be. Some Fed watchers argue whether the bank will start cutting rates, as it seems that the monetary policy reached the end of its tightening cycle.
Speaking about the economic conditions, Powell said:
“While we view current economic conditions as healthy and the economic outlook as favorable, over the past few months, we have seen some crosscurrents and conflicting signals.”
The central bank has also been focusing on easing its balance sheet since it started to hike rates from near zero levels. However, the fast pace of rate hikes has left some corners wondering whether the economy would sustain the momentum in tightening.
The argument comes as the U.S. economy posted its best growth figures during the second quarter of 2018. However, since then, growth has eased. A number of factors contributed to this, including trade wars and lower oil prices which took the spark from inflation.
The Fed’s January meeting minutes released recently showed that the officials remained divided on the growth outlook. Some members believed that rate hikes were required if the economy outperforms. However, others maintained that rate hikes could be appropriate only if inflation picked up the pace.
Powell’s testimony to the U.S. Congress offered little discussion regarding the Fed’s future monetary policy path. The central bank chief focused more on topics such as the debt ceiling, the labor markets, and the central bank’s balance sheet normalization plans.
U.S. Debt Ceiling – A “very big deal”
The Fed chair spoke about the U.S. debt ceiling which has become a hot topic once again. The national debt surged past $22 trillion in February with the U.S. government hitting this ceiling on March 1st last week.
The debt ceiling is the legally approved amount of borrowing that the government can take. With the debt ceiling hit, it could spell problems for the government as it needs to finance the budget deficit and sell bonds to raise the money.
The U.S. budget deficit, according to the Congressional Budget Office was estimated at $897 billion.
Following the December/January partial government shutdown, the debt ceiling could once again become a sticking point for negotiations to move forward. However, the U.S. Treasury Department could use its “extraordinary powers” to fund its debt obligations.
The Fed chair spent a great deal of time discussing the debt ceiling. He spoke about the possibility of the U.S. government missing its obligations to lenders. Powell stated:
“The idea that the U.S. would not honor all of its obligations and pay them when due is something that can’t even be considered… “It would be a very big deal not to pay all of our bills. That’s something that the U.S. government should always do.”
The Fed chair also spoke about the debt-to-GDP ratio which has risen to 104% during the third quarter of 2018. The data came from the Federal Reserve Bank of St. Louis.
He said that the U.S. government was on an unstable path fiscally.
Labor market – A responsibility for Fed and Congress
Powell also spoke about the U.S. labor markets. These have remained a bright spot and a strong pillar in supporting the economy. He said that it was the responsibility of both the Federal Reserve and the Congress.
He claimed that the percentage of prime-age workers who were employed or seeking work had increased in recent months. However, he stated that it still lagged behind the figures from developing economies.
Powell said that this trend was very troubling. Powell told the Banking Senate Committee:
“As the country ages, labor-force participation should decline at a very steady level. Nonetheless, even allowing for that, we’re lower than we need to be,”
The U.S. labor force participation rate edged slightly higher in January. It increased to 63.2% from 63.1% in the previous year, as data from the Labor Department recently showed. This was the highest participation rate in the U.S. in nearly six years. However, Powell said that this was still a long way off the levels seen during the pre-crisis era.
Some economists note that an increased labor force participation rate would push the jobless rate higher. The U.S. unemployment rate is currently holding steady at a half a decade low of 4% in January. This too, is according to data from the Labor Department.
Powell claimed that this could be one of the reasons for the unemployment rate to remain so low. This is because the labor force participation rate is not up to the mark yet. He called for new legislation from the Congress to address the labor force participation noting that it was not just the Fed’s responsibility.
He affirmed that recent trends in the labor market were positive and that the Fed officials well acknowledged it. However, he mentioned that they do not know how long this could be sustained, stating:
“We need a broad policy focus on how to sustain labor-force participation, including not just through Fed policy but through legislative policy as well,”
Powell on Fed’s balance sheet
Powell also spoke about the Fed’s plans to reduce its balance sheet. He claimed that the balance sheet would leave room for a lot of reserves. The Fed Chair went on to outline how the balance sheet would look by the time the bank completed monetary policy normalization.
He described that the Fed will have a reserve balance of $1 trillion and also maintain a buffer. He said that this was a reasonable starting point. Powell’s views on the balance sheet toed the line from the comments by Williams, the NY Fed president a few weeks ago.
Powell said that the central bank’s balance sheet was larger compared to before the Great Recession, but that this was to be expected.
Since the global financial crisis, the Fed has required banks and lending institutions to hold larger amounts of liquid assets to act as a buffer in times of unforeseen crisis.
“One of those assets that the banks like to hold to satisfy those requirements is bank reserves,” Powell said.
Powell stated that the demand for reserves would be substantially higher than it was before the crisis. He also doubted if it would ever be lower again.
The central bank has been looking at reducing its holdings of the Mortgage-backed securities and U.S. Treasuries. The bank started to buy these after the financial crisis to support the economy and to inject liquidity into the markets.
In its recent unwindings of the balance sheet, the central bank has unwound nearly $310 billion of assets since the middle of 2018. At the time of writing, the Fed’s balance sheet stands at $3.9 trillion.