Jerome Powell Says Rising Oil Prices Won’t Prompt Fed Rate Hikes

Jerome Powell made a notable statement today.

Recent critiques of the nearing former Federal Reserve Chairman abound, but let’s shift focus to something positive from his remarks to Harvard students on Monday: an opportunity to commend his approach.

The key takeaway from Powell was clear: The Fed tends to sidestep energy shocks. He referenced historical examples, starting with the Iran war, explaining that disruptions in energy supply are often temporary. Moreover, monetary policies typically experience long and volatile delays, making them ill-suited for immediate economic disruptions.

“By the time the effects of tightening monetary policy are felt, the oil price shock will probably be long gone, which ends up impacting the economy at entirely the wrong moment, so we usually overlook any supply shocks,” Powell noted.

He aimed at the growing optimism in the bond market regarding potential Fed interest rate increases fueled by rising energy prices contributing to inflation. According to CME Group’s FedWatch tool, there was more than a 20% chance of a rate hike by year’s end, with many in the market anticipating something as early as September.

The issue with this perspective, however, lies in the potential economic burden posed by high energy prices in the short to medium term. When households allocate more money to fuel their vehicles, that’s funds not spent elsewhere in the economy. Spending is diverted from other products and services towards energy. Given that the US is a significant energy producer now, this isn’t merely a tax on the economy, but rather a shift that could decelerate growth. There will, of course, be a recirculation of dollars back to non-energy sectors, but likely with a delay.

A critical question for the markets recently was how well the Fed understands this dynamic. They risk adopting an overly hawkish approach if they believe that rising energy costs will lead to higher consumer prices across the board. However, this is a misstep the Fed is less likely to make. Without monetary stimulation, a broad and persistent rise in inflation isn’t feasible. Higher pump prices typically limit the pricing power of distributors in other sectors.

A decline in stock prices often coincides with rising energy costs, which can complicate financial conditions and result in contraction and deflation. Thus, disruptions like the closure of the Strait of Hormuz not only exert direct pressure on growth and prices outside the energy sector but also indirectly impact the stock market.

Powell’s remarks helped temper the panic over oil price spikes from the previous week. Shortly after his speech, the implied probability of a rate hike this year fell below 5%, while the likelihood of a cut—which had dropped to 3% on Friday—now stands at nearly 15%.

Of course, Powell hasn’t abandoned a cautious stance completely. He indicated that the Fed remains conscious of the theory of inflation expectations and the risk that climbing energy prices could lead to self-perpetuating inflation expectations. However, he emphasized that up until now, no such phenomenon has manifested. Inflation expectations appear to be “firmly stable,” and the latest consumer sentiment survey from the University of Michigan even showed a decrease in five-year inflation expectations.

Powell’s Critique of Progressive Monetary Policies

Powell’s reserve isn’t confined solely to monetary policy. He also discussed what the Fed shouldn’t pursue through its direction. As his term nears its end on May 15, he reaffirmed the need for Fed officials to “stay on course” regarding monetary policy and its effects on prices and employment. This served as a subtle critique to those advocating for the Fed to tackle climate change due to “transition risks” or to influence lenders and borrowing companies to adopt DEI policies to mitigate “reputational risks.” Powell argued that incorporating non-monetary measures would compromise the Fed’s independence and effectiveness.

He acknowledged that the Fed’s supervisory and regulatory functions should align to some extent with White House policies. Although grounded in Congress’s authority to manage money, Fed banking supervision is fundamentally an executive function, a fact recognized when this role was established. The vice-chair in charge of supervision is appointed by the president, who holds the power to dismiss anyone from that position. Powell stated that the chair’s influence is just one voice among the seven-member Fed Board, with the vice chair leading oversight efforts.

As Powell’s term wraps up in six weeks, there might be mixed feelings about his leadership. Yet, his remarks on Monday served as a reminder that Powell is fundamentally in control. By resisting the urge to react impulsively, he indicated that the Fed does not plan to conflate energy shocks with financial crises, potentially preventing unnecessary economic strain. Furthermore, by maintaining that the Fed would confine itself to its core responsibilities, he has set up a more straightforward environment for his successor than many anticipated. If this is the beginning of what could be seen as a farewell tour for Powell, he has indeed chosen an effective opening act.