Slowing growth in Europe and China and “elevated” uncertainty over Brexit and trade are continuing to weigh on the Federal Reserve’s policy outlook, chairman Jay Powell said, even as he gave a broadly favourable health check to the US economy.
In testimony to a US Senate committee, Mr Powell repeated the central bank’s “patient” approach to interest rate changes, vowing to carefully monitor a host of unresolved questions, including the direction of Brexit talks and ongoing US-China trade negotiations.
“While we view current economic conditions as healthy and the economic outlook as favourable, over the past few months we have seen some cross-currents and conflicting signals,” Mr Powell said in his prepared remarks. “Financial markets became more volatile towards year-end, and financial conditions are now less supportive of growth than they were earlier last year.”
The US central bank in January shelved its prior plans for further gradual rate increases after a choppy period in which the Fed was accused in markets of being unduly hawkish about monetary policy. Minutes to that meeting showed many policymakers now expect to complete the job of reducing its multitrillion-dollar balance sheet this year, adding to a more buoyant mood in financial markets over recent weeks.
Mr Powell said some economic data have “softened” in the past two months, on the same morning that data showed a sharp decline in residential housing starts in December as well as a deceleration in home-price growth.
But the Fed chairman insisted the US still remains on track for spending gains during the current quarter, and that the labour market remains strong. Gains in labour force participation among people aged 25-54 continued over the past year, he said, and wage growth is strengthening — particularly for lower-skilled workers.
The effects of the federal government shutdown prompted by a stand-off over border wall funding should be “fairly modest” and largely unwind over the next months, he said.
While recent declines in energy prices would likely push headline inflation down further below the Fed’s 2 per cent goal, those effects were deemed “transitory”, and price growth was still seen running close to 2 per cent.
Despite that healthy economic backdrop, Mr Powell signalled that the Fed will continue to take a cautious approach to policy in the wake of its last interest rate increase in December. In the January meeting the Federal Open Market Committee decided ongoing government policy uncertainty merited a “patient approach” to policy.
The chairman said that quicker wage growth seen recently was not “troubling” from the point of view of inflation. Given “muted” inflation pressures, “this is a good time to be patient and watch and wait and see how the situation evolves,” he said. The Fed, he added, was learning that there was still slack in the jobs market, as individuals enter the active workforce. This, he said, had implications for monetary policy.
Recent signals that the Fed is reconsidering its approach to its inflation target prompted a challenge to Mr Powell by Pat Toomey, a Republican senator from Pennsylvania.
The Fed is reviewing its inflation mandate this year given the higher risk that it will be forced to slash rates to near-zero levels to counter future downturns. Officials are debating new approaches, which could sometimes lead them to deliberately aim for above-target inflation in order to achieve their inflation goal on average over a period of years.
Mr Toomey said his first reaction was to be “pretty concerned” about that idea, given historic problems with high inflation. Mr Powell said that no decisions had been made, but these issues were going to be the subject of “careful consideration” over the year and beyond.
One of the key questions facing the Fed this year is determining exactly when it should stop its balance sheet reduction programme, after total assets shrank from a peak near $4.5tn to around $4tn. The plan began to unsettle markets late last year, prompting the Fed to reassure traders it was ready to change tack if financial or economic conditions merited it.
In his opening remarks, Mike Crapo, the Republican senator from Idaho who chairs the banking committee, said he wanted to know what factors Mr Powell will be considering in deciding the right size of its balance sheet and the quantity of reserves that will be needed for it to set monetary policy.
Responding to questions from Mr Crapo, the Fed chair said that market estimates putting the quantity of reserves at around $1tn “plus a buffer” were a reasonable indicator of where the Fed might wind up following its balance sheet rundown.
Whereas the Fed was on the receiving end of attacks from Donald Trump when it was lifting rates last year, presidential criticism has evaporated as the central bank adopts a more dovish stance. Mr Powell, who met the president and Treasury secretary Steven Mnuchin for a private dinner earlier this month, declined to comment when asked by Democratic senator Brian Schatz whether anyone in the White House had communicated with him about interest rates.
After a pause, Mr Powell said it was not appropriate for him to comment on private conversations with other government officials. The Fed chair also dodged a question earlier in the hearing about comments from his predecessor Janet Yellen, who this week said in a radio interview that she did not believe Mr Trump understood the Fed’s economic goals.
“I won’t have any comment on that for you, senator,” said Mr Powell.
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