Fed Chair Jerome Powell Says Higher Interest Rates Could Cause a Recession

Federal Reserve Chairman

Jerome Powell

said the central bank’s battle against inflation could lead it to raise interest rates high enough to cause a recession, offering his most explicit warning this year.

“It’s not our intended outcome at all, but it’s certainly a possibility,” Mr. Powell said Wednesday during the first of two days of congressional hearings. “We are not trying to provoke and do not think we will need to provoke a recession, but we do think it’s absolutely essential” to bring down inflation, which is running at a 40-year high.

His remarks underscore the challenge facing the central bank as it raises interest rates at the most rapid clip since the 1980s to slow the economy and cool inflation.

Jerome Powell told lawmakers that letting high inflation become entrenched could be more painful than a recession.



Photo:

Ting Shen/Bloomberg News

The Dow Jones Industrial Average pared early losses after the release of Mr. Powell’s testimony on Wednesday morning but closed down 0.15%, or 47.12 points. The yield on the benchmark 10-year U.S. Treasury note declined to 3.155% from 3.304% Tuesday. Yields fall when prices rise.

Rising fuel costs and supply-chain disruptions from Russia’s war against Ukraine have sent prices up in recent months. Those pressures have added to already-high inflation as demand surged last year from the reopening of the economy and aggressive government stimulus.

The central bank is seeking to engineer a so-called soft landing by cooling the economy’s growth enough to lower inflation, but without causing a downturn.

During two hours of testimony Wednesday and at a nearly hourlong news conference last week, Mr. Powell never mentioned a soft landing and instead only referred to it as a goal when he was asked about it.

“The events of the last few months around the world have made it more difficult for us to achieve what we want,” Mr. Powell told the Senate Banking Committee on Wednesday. Achieving the Fed’s 2% inflation goal with a strong labor market would be very challenging, he said. “We’ve never said it was going to be easy or straightforward.”

That marked a notable change from the last time Mr. Powell appeared on Capitol Hill, just days after Russia’s invasion of Ukraine. “I think it’s more likely than not that we can achieve what we call a soft landing,” he told lawmakers on March 2.

Since then, the Fed has raised its benchmark federal-funds rate three times from near zero to a range between 1.5% and 1.75%, including a 0.75-percentage-point rate rise last week, the largest in 28 years. Mr. Powell and several colleagues have signaled that another increase of that magnitude could be warranted at the Fed’s next meeting, July 26-27.

“We’re looking for…compelling evidence that inflation is coming down, and we don’t have that,” said Mr. Powell. “There are lots of stories out there about how this should happen, and some people think it’s very clear that it will. Until we actually do see it happen, we need to keep moving.”

​’The events of the last few months around the world have made it more difficult for us,’ Jerome Powell testified on Wednesday in Washington. ​



Photo:

Win McNamee/Getty Images

Fed officials’ new projections released last week showed all 18 of them expected to raise the fed-funds rate to at least 3% this year, with most seeing it rising to a range between 3.25% and 3.5% by December. That would exceed by 1 percentage point the highest level it reached after the 2008 financial crisis, in 2018.

The fed-funds rate, an overnight rate on loans between banks, influences borrowing costs throughout the economy, including rates on mortgages, credit cards and business loans. The Mortgage Bankers Association reported Wednesday that the average 30-year fixed mortgage rose to 5.98% last week, from 5.65% in the prior week, to the highest level since 2008. That was the largest one-week increase in mortgage rates since 2009.

The Fed has faced growing criticism in recent weeks for not acting sooner to withdraw the aggressive economic stimulus measures it deployed through most of last year. Mr. Powell, who was confirmed last month to a second term on an 80-19 vote by the Senate, faced sharp questioning from lawmakers Wednesday.

Fed Chairman Jerome Powell said the central bank’s goal is to reduce inflation to 2%. The Fed approved a 0.75-percentage-point rate rise last week, the largest interest-rate increase since 1994. Photo: Elizabeth Frantz/Reuters

Several Democrats warned Mr. Powell against raising rates too aggressively because they believed supply issues over which the Fed had little control were responsible for driving prices higher.

“You know what’s worse than high inflation and low unemployment? It’s high inflation and a recession with millions of people out of work,” said Sen. Elizabeth Warren (D., Mass.) “And I hope you’ll reconsider that before you drive this economy off a cliff.”

In response to a similar concern from another Democratic senator, Mr. Powell volunteered that there could be a worse outcome for the economy than a recession. “The other risk, though, is that we would not manage to restore price stability, and that we would allow this high inflation to get entrenched in our economy,” he said. “We can’t fail on that task.”

Republicans, meanwhile, warned Mr. Powell against failing to take decisive action. “Clearly you are aware that you are going to be the person that takes the fall if inflation is not brought under control,” Sen. Mike Rounds (R., S.D.) told Mr. Powell.

Sen. Richard Shelby (R., Ala.) referred to concerns about high inflation that he had raised with Mr. Powell at a hearing last summer. “I believe the Federal Reserve and this administration failed the American people by not heeding these warnings a year ago and by not acting sooner to address it,” he said.

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The hearing didn’t shed much light on difficult trade-offs the central bank could confront in the next year, especially if its policy steps weaken the job market but don’t bring down inflation in a convincing fashion.

A new research paper from a senior Fed economist published Tuesday found slightly more than a 50% chance of a recession over the next four quarters and a two-thirds probability of a downturn over the next two years. Those probabilities are at levels last seen in mid-2019, when the Fed was shifting from raising rates to cutting them.

Separately, an economic model maintained by the New York Fed forecast that the U.S. economy could slow down faster than previously anticipated to a pace consistent with a recession next year. The model, which isn’t an official bank forecast, sees just a 10% chance of a soft landing, defined as annual gross domestic product growth slowing but staying positive over the next 2½ years. The probability of a hard landing, in which GDP declines by 1% or more from a year earlier in at least one quarter over the next 2½ years, is about 80%, according to the projection.

Economists surveyed by The Wall Street Journal last week saw a 44% likelihood of a U.S. recession in the next 12 months, a level usually seen only on the brink of or during actual economic downturns since the Journal began asking the question in mid-2005.

Nathan Sheets,

chief economist at Citigroup, said Wednesday he now sees the chance of a global recession approaching 50%.

“A series of severe supply shocks continue to rip through the global economy,” wrote Mr. Sheets, a former senior Treasury Department official and Fed economist, in a report. “As the year began, we were hopeful this narrative would be shifting, but the headwinds instead seem to have become more intense and debilitating.”

Mr. Powell said he didn’t see the likelihood of recession “as particularly elevated right now.” But he added, “You should know that no one is very good at forecasting recessions very far out.”

Mr. Powell said there were signs that interest-sensitive sectors of the economy were slowing due to the Fed’s rate increases. “You’re seeing the beginnings of job growth slowing to more sustainable levels, and…there’s obviously risk in that,” he said. “Weaker outcomes are certainly possible.”

Separately, Chicago Fed President

Charles Evans

warned of potential hazards Wednesday from the central bank’s more aggressive rate-rise posture. “We’re obviously taking on risk when we want to slow demand to keep it in line with supply,” he told reporters after a speech in Cedar Rapids, Iowa. “To think that we can fine-tune something like this with tremendous precision—I mean, we just don’t have that ability.”

Write to Nick Timiraos at [email protected]

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