Dive Brief:

• Federal Reserve Chair Jerome Powell voiced a commitment to curbing the highest inflation in four decades while welcoming the increase in borrowing costs since the central bank in March began its most abrupt withdrawal of stimulus since 2000.
• “It's been good to see financial markets reacting in advance based on the way we're speaking about the economy, and the consequence I mentioned is that financial conditions overall have tightened significantly,” Powell said Tuesday. “That's what we need.”
• “Inflation is way too high,” Powell said in a webcast hosted by The Wall Street Journal. “We need to bring it down and we’re going to use our tools to do that.”

Dive Insight:

Gauging the outlook for inflation and the pace of Fed tightening are just two of many challenges for CFOs as they make plans for wages, prices and capital allocation during the next several months.

Financial executives also need to track a tight labor market, the possibility of slower economic growth, rising commodity prices from Russia’s invasion of Ukraine and persistent supply chain bottlenecks from pandemic disruptions, especially widespread lockdowns in China.

The Fed’s withdrawal of stimulus has raised the cost of capital, pushing the yield on the 10-year Treasury note to nearly 3%, or roughly double the rate at the start of 2022.

Powell’s challenge is to raise the federal funds rate enough to curb the highest inflation in 40 years without undercutting employment or economic growth.

First-quarter GDP growth slumped to a 1.4% annualized rate from 6.9% in the fourth quarter primarily because of inventory reductions, a waning of fiscal stimulus aimed at offsetting harm from the pandemic and a rise in imports as congestion at U.S. ports began to ease.

Yet consumer spending, which accounts for more than two-thirds of U.S. economic activity, remained strong in April, the first full month after the central bank began to withdraw accommodation.

Retail sales in April increased 0.9% compared with March, the Commerce Department said Tuesday, while industrial output rose 1.1%, according to the Fed.

“The underlying strength of the U.S. economy is really good,” Powell said, noting retail sales and low unemployment.

At the same time, long-term inflation expectations — a measure closely followed by Powell and other policymakers, — increased in April. Respondents to a New York Fed poll in April expected 3.9% inflation three years from now, compared with a 3.7% forecast in March.

Fed officials consider “well-anchored” inflation expectations essential for averting a self-reinforcing upward spiral in wages and prices.

The employment cost index during the first quarter gained 1.4% for a 4.5% year-over year increase. The persistent rise in compensation costs increases concerns that consumer expectations for low long-term inflation will fade, prompting demands for higher pay.

Some gauges of price pressures may have peaked but remain high. The consumer index eased in April to 8.3% year-over-year from 8.5% in March while the Fed’s preferred measure of inflation – the core personal consumption expenditures price index — rose 5.2% in March compared with 5.3% in February, according to the Labor Department.

Policymakers at the end of a two-day meeting on May 4 raised the benchmark interest rate by a half percentage point and detailed plans for trimming the central bank’s $9 trillion balance sheet. Powell reiterated Tuesday that he expects a half percentage point tightening will be “on the table” at each of the coming policy meetings in June and July.

“By the standards of central bank practice in recent decades we’re moving about as fast as we’ve moved in several decades,” Powell said.

“What we need to see is clear and convincing evidence that inflation pressures are abating and that inflation is coming down,” he said. “If we don’t see that, then we’ll have to consider moving more aggressively.”

The central bank has faced criticism for acting too late to curb inflation.

“Why did they delay their response?” former Fed Chair Ben Bernanke said in a CNBC interview on Monday. “I think in retrospect, yes, it was a mistake.”

The Fed should more actively curtail price pressures, according to Alfredo Coutino, director of economic research at Moody’s Analytics.

“The Fed is well behind the curve and needs to act more aggressively to reach monetary neutrality,” he said in a report. “Inflation will not recede while monetary conditions remain in expansionary territory.”