(Chris Kleponis/AFP/Getty Images)
Federal Reserve Chair Jerome Powell sent investors mixed messages on Tuesday during his semiannual testimony to Congress.
Speaking before Congress, he said that the central bank doesn't expect to cut interest rates "until we have gained greater confidence that inflation is moving sustainably toward 2%."
But, he noted, inflation readings have come down significantly from the four-decade highs they reached two years ago. The US economy is cooling, and "more good data would strengthen our confidence that inflation is moving sustainably toward 2%."
So what can Wall Street decipher from his first day of testimony? Here are a few key takeaways.
Powell is stressed about the election: Powell was asked by multiple senators about White House politics, which he dodged. When asked about so-called Bidenomics, for example, he commented that "I wouldn't touch a sentence with that word in it."
But it's hard to avoid politics when former President Donald Trump has said that if elected he would not reappoint Powell and accused Powell of considering rate cuts to give Democrats an advantage in the 2024 elections.
That might be why Powell made sure to stress that the central bank is an independent entity on Tuesday.
"Congress has entrusted the Federal Reserve with the operational independence that is needed to take a longer-term perspective in the pursuit of our dual mandate of maximum employment and stable prices," said Powell.
The Fed's independence is reassuring for American and global capital markets, said Joseph Brusuelas, principal and chief economist at RSM US. That's because investors need to believe that central banks will be dependable and do what's best for the economy instead of stimulating economies and impacting markets ahead of elections.
"One gets the idea that the Federal Reserve is laying down a marker ahead of the upcoming presidential election," said Brusuelas. "In an era of economic populism, and the possible advent of a second Trump administration, the idea of central bank independence is far more important than is commonly understood or appreciated among elected actors and the public."
Inflation is no longer the only risk: Powell's messaging on Tuesday was largely consistent with his most recent communication about Fed policy – with one major exception. Powell subtly signaled his desire to start "recalibrating monetary policy," said EY Chief Economist Gregory Daco.
While the Fed head noted that policy decisions are data dependent, "elevated inflation is not the only risk we face," he said. "Reducing policy restraint too late or too little could unduly weaken economic activity and employment."
While the economy and labor market remain strong, US job growth slowed in June, according to the latest employment data. That's caused some analysts to fret about the Fed's timing for rate cuts – if the central bank waits too long it could send the economy into recession.
"We know the economy's performance has been remarkable. What policymakers need to evaluate is how inflation and labor market conditions will fare in the coming months," said Daco.
Market reaction was muted, but yields are up: Powell's acknowledgement that higher-for-longer interest rates could jeopardize the economy should have been good news to investors eager for rate cuts. But that message was tempered by "his mantra that the Fed is still waiting for more evidence that inflation is cooling reliably before it acts," said Chris Larkin, managing director of trading and investing at E*TRADE from Morgan Stanley.
As a result, investors mostly yawned on Tuesday. The S&P 500 closed the day less than 0.1% higher.
"The fact that the S&P 500 mostly drifted sideways during his testimony suggests traders are looking ahead to the inflation numbers," said Larkin, referring to US Consumer Price Index data due later this week. That data will help investors discern whether more progress has been made in the Fed's fight against inflation.
Treasury yields, however, moved higher on Tuesday, indicating that investors don't think a rate cut will happen in the next few meetings.
The September Fed meeting will be "live": Powell noted multiple times that every Fed policy decision is made "live" using the latest available economic data – in other words, decisions aren't made in advance. But investors still believe that the outcome of July's meeting is set: 95% are betting that the Fed will keep rates the same, according to the CME FedWatch tool.
September, however, is little more of a toss-up. About 75% of investors think the Fed will cut rates, and about 25% think they'll remain the same.
There's more to come: We'll be seeing a lot more from Powell ahead of that September meeting.
The Fed chair continues his testimony in front of Congress on Wednesday.
Powell's social calendar remains full through the end of the month: Next Monday he'll join David Rubenstein for a "wide-ranging interview on the current state of the US and global economy" at the Economics club in Washington DC, and he'll host his regular press conference following the Fed's late-July policy meeting. In August, he'll speak at the Jackson Hole Economic Symposium.
That means there's plenty of time for the Fed to recalibrate their messaging and temper market expectations.
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