Jerome Powell has a judgment to makeon how hard monetary policy is biting down on the U.S.economy.The signal came from two words: “for now,” used by theFederal Reserve chairman as a caveat in his description on Tuesdayof the central bank's plan to “keep gradually raising the federalfunds rate.”His simple phrase in testimony before the SenateBanking Committee highlights the uncertainty facing the Fed as itgauges how high to raise rates as fiscal stimulus boosts growth,amid potential headwinds from an escalating trade war.“This chairis trying to retain optionality and flexibility with all theuncertainty about fiscal policy's impact on long-term growth,” saidPriya Misra, head of global rates strategy at TD Securities in NewYork. “He is leaving the door open to slow down the pace of hikesor not hike beyond neutral.”Investors heard the chairman loud andclear. The Standard and Poor's 500 index rose 0.4 percent to 2,810,while yields on U.S. 10-year notes were little changed at 2.86percent.The conditional description of the outlook for interestrates was a small but important check against the certaintysometimes falsely conveyed by the Fed's “ dot plot,” or theestimates that policymakers update every quarter on theirexpectations for future policy.

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Fed Tightening

In June, officials signaled they thought monetary policy would needto become restrictive by the end of next year. They penciled inrates of 3.1 percent by end-2019, versus their 2.9 percent medianestimate of the neutral rate which neither supports nor slows theeconomy. Rates were seen at 3.4 percent by the end of2020.Powell's “for now” reference“speaks to the idea that if the data starts to deteriorate, saybecause of trade tensions, they'll slow down,” said Joseph Song,senior U.S. economist at Bank of America Corp in New York. “But itworks the other way. The tax cuts potentially could be morestimulative and could lead to a faster pace of tightening.”Severalregional Fed presidents, including Neel Kashkari of Minneapolis andRaphael Bostic of Atlanta, have already warned about the Fed's needto avoid inverting the yield curve by hiking rates so thatshort-term borrowing costs rise above longer-term bondyields.Powell, who will appear before the House Financial Servicescommittee at 10 a.m. on Wednesday, said his interpretation of thenarrowing spread between short- and longer-term rates is that itmight be saying something about how close the Fed is to the neutralrate.That judgment is a hard one to make in real time, andestimates of the neutral rate vary quite widely.The Fed's JulyMonetary Policy Report, which it prepares as part of the chairman'ssemi-annual appearance before Congress, included a section onvarious policy models that produced estimates of neutral rangingfrom 0.1 percent to 1.8 percent in real terms. Adjusting for theFed's 2 percent inflation target would put that range for neutralrates between 2.1 percent to 3.8 percent in nominal terms.Officialsoften don't know until it's too late whether monetary policy is tootight or too loose—that is, when the economy's momentum starts toslow with rising unemployment, or when financial bubblesemerge.With a couple of quarter-point hikes to go before the Fedenters the bottom of policymakers' own range of estimates for theneutral rate, which in June was 2.3 percent to 3.5 percent, Powellused his testimony on Tuesday to underscore that policy isn't on apreset path.“'For now,' suggests that the recent Fed policy ofraising rates a quarter point every quarter or so is not set instone,” Roberto Perli, a partner at Cornerstone Macro LLC and aformer Fed staff economist, said in a note to clients. “One goodreason for the Fed to slow down or even take a break is that thefunds rate is approaching its present neutral level.”

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