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The Fed: Powell paints the picture of a soft landing, says Fed can cool inflation without damaging labor market

Federal Reserve Chairman Jerome Powell said the central bank should be able to raise interest rates without damaging the job market, essentially painting a picture of a “soft landing” rather than a recession.

Moving away from the Fed’s current policy stance “should not have negative effects on the labor market,” Powell said Tuesday before a congressional panel.

Private-sector economists have noted that the Fed’s prior efforts to quell inflation in the past have more often than not resulted in recessions.

And many analysts, including former Fed officials, have warned that the Fed is now “behind the curve” on inflation. This means the Fed is likely to need to slam on the brakes – raising interest rates so much that consumer demand is curtailed.

The Fed has penciled in a plan to raise its benchmark interest rate to 2.1% by the end of 2023. Former New York Fed President William Dudley and others think the central bank will likely have to push its benchmark rate up closer to 4% to reverse easy monetary policy largely kept in place due to the COVID-19 pandemic.

Read: 4 mistakes the Fed made – from a former insider

Powell told the Senate Banking Committee that inflation came from the imbalance of supply and demand. While the Fed can cool demand, it will get some help as supply constraints ease. Lawmakers are considering Powell’s return to the Fed’s top post.

“We do think we’ll get, over the course of this year, a return to normal supply conditions,” Powell said.

Powell said he expects high inflation to last “well into the middle of the year.” If inflation persists at high levels longer than expected, the Fed will have to raise rates more over time, he added. The Fed won’t let inflation become “entrenched,” he pledged.

“We’re trying to get to a place where we’re more neutral, and then perhaps tight if that’s appropriate,” he said later.

Read: Fed’s Powell pledges to prevent inflation from developing deep roots

Powell said he didn’t think that wage gains over the past year had started an upward wage-price spiral last seen in the late 1970s that caused the Fed to raise rates sharply.

Read: These 14 bank stocks are in the best position to benefit from rising interest rates

Economists expect the Fed will remain under pressure to quickly quell the inflation upsurge.

On Wednesday, the consumer price index for December is expected to rise above 7%, the highest rate since 1982.

Another tool the Fed has to remove accommodation in the economy is to allow its its massive $8.8 trillion balance sheet to shrink. Powell signaled he’s open to allowing the balance sheet to shrink this year, but he didn’t seem as eager to start that process compared to some other Fed officials.

For instance, Fed Gov. Christopher Waller said recently he wants to start to shrink the balance sheet soon after the first rate hike, which looks increasingly likely to come in March.

Read: Fed’s Mester sees 3 rate hikes this year, starting in March

Asked for his opinion on the balance sheet, Powell said the Fed was not at the point of making decisions.

“We will be in a position to provide guidance at coming meetings,” he said. “We tend to take two, three, four meetings to work these things through,” he added.

At the same time, Powell declined to rule out selling assets to shrink its balance sheet. “We didn’t do that last time,” he said, adding “we never ruled it out either.”

Powell wasn’t pressed very much about a scandal in which three Fed officials were active stock traders while the Fed was trying to prop up financial markets in 2020. Two regional Fed bank presidents left the Fed last year after their trading was disclosed.

Fed Vice Chairman Richard Clarida, whose trading has also been questioned, announced Monday that he was leaving his post later this week. Clarida recently amended his financial disclosure forms in a way that casts doubt on his assertion that he trading in 2020 was simply portfolio rebalancing.

Dennis Kelleher, co-founder of Better Markets, said Clarida’s resignation confirms there is “an epidemic of ethical and legal violations at the highest levels of the Fed.”

Powell argued that a new rule governing trading by senior officials adopted by the Fed in October in the wake of the scandal “is easily the toughest in government.”

Earlier Tuesday, Cleveland Fed President Loretta Mester said the trading by the top Fed officials had been “technically correct” under then existing rules, but that there had been “an appearance issue” with the trading.

Even with the trading scandal, analysts think Powell’s nomination for a second term will move swiftly thought the Senate. At the same time, they predict Fed Governor Lael Brainard may face tougher questions on Thursday at her confirmation hearing to replace Clarida as Fed Vice Chairman.

Markets were encouraged with Powell’s tone and the sense that he might not support starting to shrink the balance sheet until much later in the year.

The Dow Jones Industrial Average DJIA, +0.23% recovered as Powell’s testimony progressed. The yield on the 10-year Treasury TMUBMUSD10Y, 1.747% was little changed following the hearing.

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