U.S. Fed likely to hold rates steady as Powell prepares for possible swan song

Federal Reserve Chair Jerome Powell speaks at the Federal Reserve in Washington. (AP Photo/Jacquelyn Martin, file)

Federal Reserve policymakers will gather in Washington this week in what may be Jerome Powell’s last meeting as head of the U.S. central bank, with energy prices still elevated and the Iran war at a standstill and likely to prolong uncertainty about the economic and monetary policy outlook.

A May 15 endpoint for Powell’s eight years at the Fed’s helm now appears more likely after a major obstacle to the U.S. Senate’s confirmation of his appointed successor, Kevin Warsh, was removed on Friday. As a final act, Powell will likely oversee on Wednesday another vote by the central bank’s policy-setting Federal Open Market Committee to hold its benchmark overnight interest rate steady in the 3.50 per cent to 3.75 per cent range, where it has been since December.

Still, the meeting and Powell’s press conference afterwards could settle key matters, including whether policymakers will nod to the potential for rate hikes later this year if inflation accelerates. The question of whether Powell will remain on the Fed’s Board of Governors even if Warsh is confirmed in time to run the next policy meeting in June also could be addressed.

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The U.S. Department of Justice on Friday dropped a controversial criminal probe of Powell over renovations of the Fed’s headquarters in Washington, potentially satisfying the demands of a key Republican senator who threatened to delay Warsh’s confirmation because of it.

Powell also had made an end of the probe a necessary condition of leaving the Fed’s board. Although U.S. central bank chiefs traditionally have resigned their board seats when their leadership terms have expired, Powell said last month he might stay and would “make that decision based on what I think is best for the institution and for the people we serve,” a broader test connected with President Donald Trump’s efforts to encroach on the Fed’s independence.

Powell could remain a Fed governor until January of 2028, the last full year of Trump’s presidency and a long epilog for the man the president has nicknamed “too late” for failing to deliver the big rate cuts he demanded.

The current Fed chief will likely be quizzed on his plans as well as on the economic substance of a policy debate still clouded by the U.S.-Iran war. The FOMC’s latest statement will be released at 2 p.m. EDT (1800 GMT), with Powell’s press conference to follow half an hour later.

When the war started on Feb. 28, central bankers said the impact on inflation and economic growth would hinge on how quickly it ended and whether oil prices reversed to pre-war levels of around US$70 a barrel. Eight weeks later, the bombing has paused but economic warfare is still underway, with the U.S. blocking Iranian ships from leaving the Strait of Hormuz, Iran preventing other vessels from passing through the vital waterway, and the disruption to global oil and other supply chains at a point where policymakers are taking inflation risks more seriously.

‘Very complicated situation’

Brent crude futures, the global oil benchmark, have risen about 50 per cent since the start of the war. The resulting surge in gasoline and energy prices last month helped propel the U.S. Consumer Price Index to its biggest increase in nearly four years. While expected to hold interest rates steady, U.S. central bankers will have to decide if it’s time to nod to the possibility of hiking borrowing costs if inflation continues to accelerate. The prospect of rate cuts, at least, has dwindled, with bond markets positioned for the Fed’s policy rate to remain where it is through at least the middle of 2027.

“The longer energy prices remain elevated and the strait is constrained, the greater the chances that higher inflation gets embedded across a wide variety of goods and services, various supply chain effects start to emerge, and real activity and employment start to slow,” Fed Governor Christopher Waller said last week in his final public comments on policy before this week’s meeting, tempering his previous call for lower rates to support a job market he still worries is softening.

The Fed may have to deal with both a weakening labor market and high inflation, a situation that is “very complicated for a policymaker,” Waller said.

While Waller said that dilemma could mean holding rates steady, an increasing number of his colleagues were already noting the possible need for rate hikes during their discussions at the March 17 to 18 meeting, teeing up a debate over whether this week’s policy statement would include language indicating the Fed’s next rate change could be in either direction, which would mark a significant shift. The central bank was expected to resume its rate cuts later this year, but has been on hold since December, with inflation about a percentage point above its two per cent target.

Monetary policy right now “is in a good place, and I think it’s probably going to be appropriate to maintain policy at this level for some time,” St. Louis Fed President Alberto Musalem said in a Reuters interview earlier this month.

Like other central bank officials, Musalem said an extended period of high oil prices could raise underlying “core inflation,” not just prominent headline prices like that of gasoline. He noted that, “at that point, the risk of de-anchoring inflation expectations would become relevant. Right now, inflation expectations medium to long term are very anchored, but they would become relevant, and at that point it might be appropriate to raise rates.”

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Few U.S. central bank policymakers would argue against the current hold on rates at this point, with even their most vocal advocate for cheaper money, Fed Governor Stephen Miran, recently saying he is considering slowing his recommended pace of rate cuts because the inflation outlook had become “a little bit less favorable.”

The open issue is whether the Fed’s policy statement changes to acknowledge possible hikes in borrowing costs as a next step, and how Powell characterizes the discussion.

The Fed “will stay firmly on hold at its April meeting,” Bank of America economists wrote in a note last week. “Upside risks to inflation from the Iran war haven’t dissipated. The labor data have improved. The big question is whether the forward-guidance language in the statement will indicate that risks to policy are two-sided. We think it won’t, but it’s a close call. Powell is likely to sound hawkish.”

(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao)