Jay Powell, the chairman of the Federal Reserve, has told Congress there was “hope for a return to more normal conditions” this year but signalled that the central bank intended to maintain its heavy support of the economy.
His comments pointed to no early Fed tightening of monetary policy or drawdown of asset purchases even with a brighter economic outlook — and helped technology shares claw back most of their losses after a sharp fall during early trading in New York.
Speaking to the Senate banking committee, Powell offered one of his more optimistic assessments of economic conditions since the start of the pandemic, but stressed that there were still big downside risks to the recovery that justified the central bank’s ultra-easy stance.
“In recent weeks, the number of new cases and hospitalisations has been falling, and ongoing vaccinations offer hope for a return to more normal conditions later this year. However, the economic recovery remains uneven and far from complete, and the path ahead is highly uncertain,” Powell said in his opening remarks.
“While we should not underestimate the challenges we currently face, developments point to an improved outlook for later this year,” he added.
The prospect for an improvement in the US Covid-19 situation — combined with new large-scale fiscal stimulus backed by congressional Democrats and President Joe Biden — has prompted many economists to upgrade their growth forecasts for 2021.
Some economists have warned that a burst in economic activity could trigger an unhealthy jump in inflation, which would force the Fed to start tightening its monetary policy sooner and more abruptly than expected.
The Nasdaq Composite fell by as much as 3.9 per cent early Tuesday on concerns higher rates would threaten the lofty valuations investors have placed on shares of fast-growing technology companies. But it recovered as Powell spoke and closed 0.5 per cent lower.
In addressing inflation concerns, Fed officials have played down the threat of a jump in prices, saying it was unlikely to be sustained. During the question-and-answer period with the senators, Powell said inflation dynamics did “not change on a dime” and said “there really hasn’t been lately” a strong connection between budget deficits and inflation.
Powell also pointed to unused capacity in the labour market, with nearly 10m fewer Americans employed compared with a year ago, as one of the most worrying aspects of the US economy.
The Fed has said it would not raise interest rates from their current level close to zero until it achieved full employment, inflation hit 2 per cent and was “on track” to exceed that target. It also said it would not begin to wind down its bond-buying programme until “substantial further progress” was made towards its objectives.
Yield on the 10-year Treasury note on Tuesday, up from 0.91 per cent at the end of 2020
“The economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved. We will continue to clearly communicate our assessment of progress toward our goals well in advance of any change in the pace of purchases,” Powell said.
During the testimony, Powell was repeatedly pressed by senators on the merits of Biden’s $1.9tn stimulus plan, but declined to take a position. When asked by John Kennedy, a Republican senator from Louisiana, if he would be “cool” with Congress not passing the stimulus bill, Powell responded: “That would be expressing an opinion. So that’s what I’m not doing, is expressing an opinion.”
Financial markets have already started to factor in a rosier outlook. A sell-off in US government bonds accelerated sharply last week. The 10-year Treasury note yielded 1.35 per cent on Tuesday, up from 0.91 per cent at the end of last year. Volatility in the Treasury market has risen, underlining the potential for larger swings in the weeks ahead.
Inflation-adjusted Treasury yields have also jumped, sparking concern among investors that too swift a rise could jolt risky assets and threaten Wall Street’s record stock market run.
“It really is not the absolute yield [levels] that would be concerning, it is more the speed of the movement,” said Anders Persson, chief investment officer of fixed income at Nuveen, adding that a 0.5 to 0.75 percentage point move higher in 10-year Treasury yields over a short period of time could “spook” investors.