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 against following Canada's lead and will not commit to taking a breakin raising interest rates.

While specifically noting theBank of Canada's rate hike pause one week ago, U.S. Federal Reserve chair Powell refused to echo Canadian central bank governorTiff Macklem'soptimism that he had inflationon the run.

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

In many ways, Powell's outlook on the economy wassimilar to Macklem's. In some ways, it may have been a question of whetherthe inflationglass was half full orhalf empty.

Similar to Macklem,Powellforesaw that "growth would continue but at a subdued pace,"with little fear of a deeprecession. In fact, Powell hinted that there may besigns of a disconnect between retreating inflation and jobs, with the high demand for labour meaning the exact opposite of a jobless recovery.

"I will saythat it is gratifying to see the disinflationaryprocess now getting underway and we continue to get strong labour market data," Powell said.

More evidence of whether jobs can stay strong as inflation falls will come on Friday, when the U.S. Department of Labour releases January employment numbers.

WATCH | Canada added 104,000 jobs in December:

Canadian economy gains 104,000 jobs in December, unemployment falls slightly

2 years ago

Duration 2:56

Canada's economy added 104,000 jobs in December as the unemployment rate fell slightly to 5 per cent, Statistics Canada said Friday.

This month, Canada's different method of data collection means Statistics Canada's jobs numbersarrive a weeklater. But inboth economies, the previous month's data showedjob creation remainedstrong.Canada's were spectacularly strongwith more than 100,000 jobs created, sending unemployment near a record low.

If you wonder whether the Fed pays any attention to Canada, on Wednesday Powell revealed that he does, telling reporters, "You saw what the Bank of Canada did, and I know they left it that they are willing to raise rates after pausing."

Pause could be risky

He said the Fed did not rule out doing something similar once there were clear signs inflation was on the run.

While many critics have called for the central bank to wait a few months or even a year to see if current rate increases have done enough, Powell said history has shown that pausing too soon was risky.

Rate cuts boost markets, and many in the financial and real estate sector want the Fed to relent.But there are also many voices on the other side worried that apause in rate hikes will just take us back to the days of overvalued meme stocks and crypto, saving up problems for later.

"The growing notion that inflation has peaked and the central bank will soon 'pivot'to lower interest rates has fuelled a rally so far during 2023 in the riskiest, most speculative assets," wrote Richard Bernstein, head of a New York investment firm that concentrates on longer-term market movements.

Powell continues to stand on the side of caution, repeating the idea on Wednesdaythat interest rates could still rise as high as 5.25per cent.

"It's very difficult to manage the risk of doing too little and finding out in six or 12 months that we actually were close but didn't get the job done and inflation springs back," he said.

The job's not done

But if inflation comes down faster than the Fed expects, he said, that is a much easier problem to solve by loosening up on the monetary purse strings.

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

Asked by reporters what the signal would be to indicate the Fed was close to squeezing inflation out of the economy, he said the change would be gradual not like flipping a switch.

For Canadians hearing the Fed's insistent push for higher rates, one obvious question is to what extent the two central banks can diverge in their monetary policy. If Canada were to cut rates and push the dollar down, that might well be seen as a kind of protectionism intended to makeCanadian goods cheaper in the U.S.

Also, the rates Canadians pay to borrow, whether longer-term mortgages or business loans, are based on the prices set in U.S. bonds markets. If the U.S. Fed keeps raising rates, Canadians are unlikely to escape the effects.

And while Macklem may be a little more optimistic than Powell, when it comes to inflation, they are both playing for the same team.

Borrowers and investors on both sides of the border don't like rising interest rates. But as Powell said, research by the Fed has shownthere is something they like even less. The research also shows expectations are changing.

"People really don't like inflation," Powell said.

"The fact that people do generally believe that it will come down, that will be part of the process of getting it down, and it's a very positive thing."