Powell Hampers the Federal Reserve With an Unforced Error

On the surface, it’s hard to argue that the Federal Reserve’s monetary policy meeting that concluded Wednesday was anything but a success. Although the central bank raised its key interest rate by half a percentage point in the biggest move since 2000 and Chair Jerome Powell signaled that at least two more similar increases are coming at the June and July meetings, the stock market rose the most in two years and the bond market rallied, pushing yields lower. But those moves highlight a potential strategic mistake by Powell.

The reason investors rejoiced was because Powell said at his press conference after the decision that policy makers weren’t actively considering raising interest rates by three-quarters of a percentage point to help rein in inflation, which is at a 40-year high. By some measures, futures traders were pricing in a 75% chance of such a move at the next policy meeting in mid-June. So Powell’s unexpected “dovishness” was a welcome surprise to investors.

It’s unclear why Powell decided to tamp down forecasts of a 75-basis-point increase. Perhaps he didn’t want to signal that the Fed is panicking over its inability to tame inflation and that the only way to do so is by raising rates in ever bigger increments. But by taking such a move off the table so explicitly, the Fed risks provoking the opposite of what it wants to accomplish, which is to tighten financial conditions through the demand side of the economy. As Powell told CNBC in a recent interview, “We need our policy to transmit through the real economy, and it does so through financial conditions, which means we tighten policy, broader financial conditions will also be less accommodative.”