What's next for interest rates? Fed chair may offer clues on inflation curbs as Ukraine war escalates

• Federal Reserve Chair Jerome Powell will testify before Congress Wednesday.
• Investors will be looking for clues in the Fed chair's testimony about interest rate hikes.
• In late January, Powell signaled higher rates were all but certain. But this question is how fast will they rise.

As the stock market tumbles amid the prospect of higher interest rates and an escalating war between Russia and Ukraine, investors will be looking toward Federal Reserve Chair Jerome Powell’s congressional testimony Wednesday for some clues about the road ahead.

In late January, Powell signaled that a rate hike this month was all but certain as the Fed tries to contain the nation’s worst bout of inflation in 40 years.

Since then, however, Russia has attacked Ukraine, driving up oil and gasoline prices and worsening supply chain bottlenecks, which could mean even higher inflation.

At the same time, the invasion raises the specter of slower economic growth if soaring prices and the supply snarls curtail spending, and falling stocks dampen the confidence of consumers and businesses.

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The Fed increases rates to curb borrowing, temper an overheated economy and stave rates off inflation spikes. It lowers them to spur borrowing, economic activity and job growth. Rate increases would push up rates for mortgages, auto loans, credit cards and business loans, among other borrowing costs.

“They’re in a bind,” as officials try to balance elevated inflation with a potential new obstacle for the economy, says Gregory Daco, chief economist at EY-Parthenon.

Here are three things Powell may signal during his 10 a.m. appearance before the House financial services committee:

How much will the Fed raise interest rates?

Several weeks ago, a growing faction of economists believed the Fed would raise its key short-term rate by a half-percentage point, from its current level of near-zero. That would signal the central bank's resolve at fighting inflation, they believed. Some are now backing off that prediction.

“The fallout from the Russian invasion of Ukraine will likely lead to a more conservative (quarter-point) rate lift-off,” Lydia Boussour, an economist with Oxford Economics, wrote in a research note.

While most Fed officials have voiced support for a quarter-point hike, several have continued to back a half-point move, or at least the possibility of it, despite the war.

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“Front-loading a 50-point hike would help convey .... determination to address high inflation, about which there should be no question,” Fed board member Christopher Waller said in a February 24 speech.

Powell could shed light on how most Fed policymakers view the dilemma. But with officials divided on how much to hike at the March 15-16 meeting, he also may play it close to the vest, says Kevin Cummins, chief U.S. economist of NatWest.

“Instead, he is likely to emphasize the notion of moving ‘steadily’ and that officials will be ‘nimble’ in their approach,” Cummins wrote in a note to clients, borrowing terms Powell used in his January press conference.

How many times will the Fed raise rates in 2022?

Powell also could provide clues on whether the Russia-Ukraine war will alter the Fed’s approach to rate increases over the longer term. Boussour notes the economy has remained solid. In January, retail sales surged and employers added a booming 467,000 jobs despite the threat of the Russian invasion and higher inflation.

Although the economy is set to slow this year after roaring 5.7% growth in 2021, most economists still expect a healthy gain of 3.5% to 4% as COVID-19 wanes and activity continues to rebound from the pandemic-induced recession.

Wells Fargo economist Sam Bullard estimates the Fed will boost rates five times this year while David Mericle of Goldman Sachs is looking for seven moves –a hike at each remaining meeting.

When will Fed begin shrinking its balance sheet, raising long-term rates?

In March 2020, the Fed slashed its benchmark short-term rate to near zero and began buying Treasury bonds and mortgage-backed securities, initially to stabilize the financial system and then to lower long-term rates for consumers and businesses.

The purchases have swelled the Fed’s balance sheet by $4.5 trillion, according to TD Economics.

The Fed has said it will gradually trim the holdings by not reinvesting the proceeds from some of the assets as they mature rather than selling the bonds outright, which could disrupt markets. The sales are also likely to push up long-term rates, such as for mortgages.

The Fed has said it will begin scaling down the balance sheet after rate hikes have started, but Powell could provide a somewhat more specific timetable. Bullard expects the reduction to start in June while Mericle thinks it will be July.