U.S. rates to keep rising as Federal Reserve says Canadian-style pause could be risky

The world’s most powerful central banker, Jerome Powell, has decided not to follow Canada’s lead and will not decide to take a break from raising interest rates.

While specifically noting the Bank of Canada rate hike that paused last week, U.S. Federal Reserve Chairman Powell refused to echo Bank Governor Tiff Macklem’s optimism that he was experiencing inflation.

“I think it would be premature, it would be very premature, to declare victory,” Powell said at the Fed’s monetary policy news conference on Wednesday.

In many ways, Powell’s views on the economy are similar to Macklem’s. In some ways, it may be a question of whether the inflation glass is half full or half empty.

Like Macklem, Powell predicted that “growth will continue but at a slower pace,” with fears of a deep recession. In fact, Powell signaled that there are signs of a disconnect between rebounding inflation and employment, with high labor demand meaning the opposite of a recovery in unemployment.

“I would say it’s encouraging to see the process of disinflation now underway and that we continue to get strong labor market data,” Powell said.

Further evidence that jobs may remain strong as inflation fell on Friday when the US Labor Department released its January employment numbers.

WATCH | Canada added 104,000 jobs in December:

This month, Canada’s different data collection method means Statistics Canada’s job numbers are coming in a week later. But in both economies data from the previous month showed job creation remained strong. Canada has been very strong with more than 100,000 jobs being created, leaving unemployment near a record high.

If you’re wondering if the Fed is paying attention to Canada, on Wednesday Powell announced that he did, telling reporters, “You see what the Bank of Canada is doing and I know they’re leaving if they’re willing to raise rates after the break.”

Resting can be dangerous

He said the Fed did not take the same action if there were clear signs of inflation.

While many critics have asked the central bank to wait a few months or even a year to see if the current rate hike is enough, Powell said history shows that pausing too soon is also risky.

The rate cut boosted markets and many in the financial and real estate sectors wanted the Fed to back off. But there are also many voices on the other side worried that a pause in rate hikes will only take us back to the days of overvalued meme stocks and crypto, saving up problems for later.

“The persistent thought that inflation has peaked and the central bank will “pivot” to cut interest rates has led to a rally so far in 2023 in the riskiest, most speculative assets,” wrote Richard Bernstein, head of a New York investment firm that concentrates on the movement long term market.

Powell remained cautious, repeating the idea on Wednesday that interest rates could still rise to 5.25 percent.

“It’s very difficult to manage the risk of doing too little and realizing in six or 12 months that we’re close but we’re not getting the job done and inflation is rising again,” Powell said.

The project is not finished yet

But if inflation falls faster than the Fed wants, he said, that’s a problem that’s easier to solve by loosening the purse strings.

“In this situation where we have the highest inflation in 40 years, you know, the job is not done,” Powell said.

Asked by reporters what signals would indicate the Fed is close to taking inflation out of the economy, he said the change would be gradual — not like a switch.

For Canadians hearing the Fed’s continued push for higher rates, one obvious question is how far the two central banks can diverge on monetary policy. If Canada were to cut tariffs and push the dollar, it might be seen as a type of protectionism intended to make Canadian goods cheaper in the US.

Also, the rate Canadians pay to borrow, whether it’s a long-term mortgage or business loan, is based on the price set in the US bond market. If the US Fed continues to raise rates, Canadians cannot escape the effects.

And while Macklem may be a bit more optimistic than Powell, when it comes to inflation, they play on the same team.

Borrowers and investors on both sides of the border did not like the rate hike. But as Powell said, research by the Fed has shown there is something they like even less. The study also shows that expectations are changing.

“People really don’t like inflation,” Powell said.

“The fact that people generally believe that it will go down, that will be part of the process of going down, and that is very positive.”