Jerome Powell mentioned “disinflation” 15 times in his Fed Q&A this week. Here’s how it can drive the markets.

  • Fed Chairman Jerome Powell mentioned disinflation 15 times in a Q&A with reporters this week.
  • The Fed raised interest rates by 25 basis points on Wednesday in the latest tightening gesture.
  • Powell’s announcement that prices are slowing has reinforced market speculation that rates could start to fall this year.

Jerome Powell was keen to remind investors that the economy is still in the throes of dealing with high prices and a potential slowdown.

But the Federal Reserve chairman may have been trying to convey a different point of view when he answered questions from reporters on Wednesday after raising interest rates by 25 basis points.

Powell said “it’s good to see that the disinflationary process is now underway,” one of 15 references to the term, while also warning investors that the process has yet to go through before a rate cut can be considered.

Investors, who have been optimistic since the beginning of the year as inflation continues to decline, have been encouraged that borrowing costs may start to decline ahead of schedule this year.

What did Powell say?

“It’s encouraging to see the disinflationary process now underway and we continue to get strong labor market data,” Powell said in a speech on Wednesday.

“These are the early stages of disinflation and it’s very nice to be able to say that we are now in disinflation,” he later said in a Q&A, warning that it could take time to fully penetrate the economy.

With his repeated references to disinflation, Powell sought to reinforce the idea that price pressures were easing, despite his reminders that it was early on and “a couple more rate hikes” remained likely.

Powell’s constant references to slowing prices, along with the idea that financial conditions have tightened – implying that rate hikes are working – have caught investors’ attention, adding fuel to a rally that has gone on for more than a month.

What is disinflation?

Disinflation means slower price increases, and this is happening in the US right now. Annual consumer price inflation fell to 6.5% in December, the lowest level in more than a year, from a 40-year high of 9.1% in mid-2022.

Core inflation, a measure that excludes more volatile energy and food components and is seen as the best indicator of tight price pressures, also eased on a monthly basis.

Supply chain disruptions that were felt around the world after COVID-19 restrictions were lifted are beginning to ease, Powell said, and the recent reopening of the Chinese economy has helped ease cost pressures.

“You see that inflation is now coming down because supply chains have been established, demand is shifting back towards services, and shortages have narrowed,” he stressed.

The speed at which price pressures are easing will be a key factor in the Fed’s interest rate decisions after a staggering 450 basis point hike in base rates since March last year. If inflation continues to fall to the 2% target set by the central bank, policymakers will have no reason to keep rates high.

Disinflation has helped boost investor sentiment even amid a widely anticipated recession, pushing US stocks up nearly 9 percent since the start of the year.

What does this mean for investors?

While the markets had already priced in a slight rate hike at the latest central bank meeting, Powell’s announcements did help stocks gain during the day.

Investors appear to be playing chicken with the Fed over the likelihood that it will execute its plan to cap rates at around 5.1%, requiring two more 25 basis point increases, or that borrowing costs have reached its peak.

Powell found himself in a quandary between trying to remind markets of his intention not to cut rates this year and force a sell-off with overly hawkish rhetoric. According to EY Parthenon chief economist Greg Dacko, the result was too dovish.

It’s entirely possible that Powell will sound more hawkish in the coming weeks to offset the optimism Wednesday, Dako said.

“This easing in financial conditions is clearly not what the Fed was aiming for, and we expect the cacophony of Fed speeches in the coming weeks to be aimed at refocusing the message,” Dacko said in his analysis.

“In other words, the hellish tango will continue as the Fed and the markets try to find synchronized rhythms again.”

For its part, EY Parthenon said a couple of interest rate cuts remain a “likely possibility” for 2023.

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