Jerome Powell signalled his support for a quicker withdrawal of the Federal Reserve's massive asset purchase programme in comments that raised the spectre of earlier interest rate rises next year and exacerbated a stock market sell-off.
The Fed chair's testimony at a congressional hearing roiled markets, which were already under pressure after the chief executive of Moderna predicted that existing vaccines would be less effective against the new Omicron coronavirus variant.
In response to lawmakers' questions, Powell admitted the risk of higher inflation had increased and said the US central bank could respond by speeding up the withdrawal of stimulus measures it put in place at the onset of the pandemic.
"The economy is very strong and inflationary pressures are high," he said. "It is therefore appropriate in my view to consider wrapping up the taper of our asset purchases . . . perhaps a few months sooner."
Powell said he expected the Federal Open Market Committee to discuss a speedier taper at its next meeting, which will take place on December 14 and 15.
The central bank began scaling back its US$120 billion-a-month asset purchase programme several weeks ago by US$15b a month, a pace that put it on track to cease its bond buys in June. But Powell's comments suggest the Fed could speed up that timeline significantly, paving the way for it to start raising interest rates from rock bottom lows.
US equity markets weakened following Powell's comments, with the benchmark S&P 500 falling 1.9 per cent and the tech-heavy Nasdaq Composite declining 1.6 per cent for the day.
The yield on the two-year Treasury, among the most sensitive to monetary policy adjustments, sold off sharply, rising 0.07 percentage points to 0.56 per cent. The yield had been as low as 0.44 per cent earlier in the trading day. Yields rise as bond prices fall.
Traders modified their bets on how hawkish a stance they expect the Fed to take in the coming months — a U-turn on the previous few days, when investors had wagered that the emergence of the Omicron variant would prompt the central bank to take a more patient approach to raising rates.
Implied rates on federal funds futures jumped, with markets pricing in just over two quarter-point rate rises by the end of next year.
Given that several Fed policymakers are keen to tighten policy, it would take "a deterioration in the public health situation over the next two weeks to prevent the FOMC from deciding to quicken the pace of tapering at the next meeting", Michael Feroli, an economist with JPMorgan Chase, said.
Powell, who was recently nominated for a second term by President Joe Biden, on Tuesday acknowledged the risks to the US economy from rising Covid-19 cases and the new variant. But he nonetheless struck a markedly more hawkish tone on inflation and the Fed's readiness to use its tools to tame it.
The Fed chair said the price increases that propelled inflation to its fastest pace in 30 years had spread "much more broadly" across the economy in recent months, leading to an elevated threat of "persistently higher inflation".
While Powell said he still expects inflation to abate "significantly" over the next year as supply and demand imbalances are resolved, he said it was no longer appropriate to describe price pressures as "transitory".
"I think it's probably a good time to retire that word and try to explain more clearly what we mean," said Powell.
When asked about inflation on Tuesday, Jen Psaki, White House press secretary, said: "No matter how you want to label it . . . our view is that, and the view of the Federal Reserve, private sector forecasters and the markets . . . is that inflation will ease over time."
Reducing inflation has recently become a significant focus of the Biden administration, which used its early days in office to try to stimulate demand. It is facing considerable pushback from Republicans and even some democrats over its proposed US$1.7 trillion spending bill, amid claims that it could propel prices higher.
Janet Yellen, US Treasury secretary, who appeared at the congressional hearing alongside Powell, argued the spending bill would in fact reduce expenses for families by lowering the cost of childcare and education.
"The Build Back Better plan contains support for households to help address some of the most burdensome and most rapidly rising costs that they face."
- Additional reporting by Lauren Fedor in Washington.
Written by: Colby Smith and Eric Platt
© Financial Times