Jackson Hole 2023 Preview: Weighing the "Confidence" Evidence
Look for FED Chair Powell to build on his closing message from last year: "We will keep at it until we are confident the job is done."
Dovish hope abounds heading into Powell’s speech at Jackson Hole tomorrow. This hope is due in part to the Fed’s attempt to engineer a “controlled demolition” of economic demand by injecting just enough uncertainty about their resolve, but is mostly the result of financial market participants’ on-going disbelief that the Fed will do whatever it takes to bring inflation back to 2% on a sustained basis.
A very hawkish policy shift has been underway since June, crystal clear preparation of the market for a hawkish speech from Powell at Jackson Hole. Look for Powell to build on his closing message from last year by weighing the “confidence” evidence that has accumulated since Jackson Hole 2022.
At Jackson Hole 2022 Powell defined “confidence” as: a sustained period of below-trend growth, some softening of labor market conditions, and “higher for longer” interest rate policy.
Look for Powell to: emphasize the fact growth has not been below trend by enough for long enough; downplay the need to drive the unemployment rate up to the June SEP target of 4.5%; and explicitly define the threshold for rate cuts as the YoY “supercore” inflation rate falling to its pre-pandemic average.
As I finish off this write-up at 3:36pm EST, equities are down on the day. Look for Powell to send a hawkish message wrapped in an extra soft teddy bear hug to manage the financial conditions tightening that is likely to ensue ahead of the September 19-20 FOMC.
With YoY CPI almost 3% at last print and the unemployment rate near its cycle low at 3.5%, dovish hope has permeated the vast array of Jackson Hole preview pieces ahead of Powell’s speech on Friday. On Tuesday the Wall Street Journal led off its part 2 Jackson Hole preview piece with:
“Much of the work lowering inflation is done: Amid the most aggressive series of interest rate increases in four decades, it has fallen to 3.2% from 9.1%.
“This good news presents the Federal Reserve with a new thorny question. How aggressive should it be in squeezing out what’s left?”
This morning Politico led off its Jackson Hole preview with:
“Federal Reserve Chair Jerome Powell, who last year bluntly warned that the battle against inflation would cause ‘some pain,’ faces a more delicate task as he once again addresses people across the globe.
“That’s because his hope now is to avoid pain.”
And lastly, live from Jackson Hole this morning CNBC broke down the “dove case” versus the “hawk case” saying:
“Here is the dove case that we’re going to be listening for…”
“Here is what the hawks would say…”
This dovish hope is in part intentionally conjured by the Fed itself as it seeks to engineer a “controlled demolition” of economic demand (make no mistake, an even larger part of this dovish hope is just flat out disbelief in the Fed’s resolve to bring inflation back to 2% on a sustained basis). The more there is an expectation on the part of financial market participants that the Fed isn’t really that serious about getting inflation back to 2%, the more support there is for asset prices. And in the Fed’s view, as long as asset prices are well behaved (i.e. financial stability isn’t a concern) they can maintain tight monetary policy for as long as it takes to bring inflation back to 2%.
Prominent FED watcher Jason Furman’s recent piece in the WSJ about raising the inflation target to 3% is the perfect example of floating just enough doubt about the Fed’s resolve to ensure financial markets don’t unravel in an uncontrolled fashion. For those paying close attention, the Fed has made it crystal clear that not only are they NOT going to raise the inflation target, but the 2% inflation target is intimately entwined with the labor side of their mandate. Floating a shift to a 3% target was a very obvious ruse designed to soften the blow of the very hawkish policy shift that has been underway since June and is set to hit financial markets in full starting with Powell’s speech on Friday.
But before we look ahead to Friday, we need to look back at Powell’s now-infamous 8-minute speech last year at Jackson Hole.
Jackson Hole 2022
“Today, my remarks will be shorter, my focus narrower, and my message more direct.”
Last year at Jackson Hole Powell very succinctly outlined what it would take to bring inflation back to 2%:
Forceful use of the Fed’s tools
A sustained period of below-trend growth
Very likely some softening of labor market conditions
Maintaining a restrictive policy stance for some time
He closed the speech with three lessons from history that are guiding the Fed’s “monetary policy deliberations and decisions”:
A central bank’s responsibility to deliver price stability is unconditional
The longer high inflation continues, the greater the chance that expectations of higher inflation will become entrenched, even if current inflation expectations appear to be well-anchored
The employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting
“We will keep at it until we are confident the job is done.”
With YoY CPI close to 3% and the unemployment rate at 3.5%, the consensus view is that the Fed has all but nailed the “soft landing”; another hike is largely meaningless, as the OIS market currently has the Fed launching a rate cut cycle starting in early 2024; and on Friday Powell will give a speech detailing the remaining path to a soft landing. But the full weight of the FED communication evidence since June strongly suggests this consensus view is dead wrong on the substance of Powell’s speech (his tone will be much softer than last year, but the message will be the capstone of the hawkish policy shift underway since June).
Why? Because the Fed is far from confident that the job is done.
Look for Powell’s speech to not only reiterate the fact the Fed will “keep at it until it’s confident the job is done,” but to more explicitly define what the Fed means by “confidence”.
Definition of Confidence
The Fed began to communicate to the market its high-level definition of “confidence” via former FRB New York President Bill Dudley in a July 14, 2022 Bloomberg op-ed:
“…the Fed needs to be confident that it has succeeded in pushing inflation back down on a sustainable basis. Chair Powell correctly understands that the costs of not hitting the 2% target over the next year or two outweigh the costs of a mild recession – because failure would cause inflation expectations to rise, necessitating an even tighter monetary policy and a deeper downturn later. In the late 1960s and the 1970s, the central bank tightened monetary policy enough to push inflation lower at times, but it reversed course too soon. As a result, the peaks and the troughs for inflation kept moving higher — until the 1980s, when Paul Volcker had to force a deep recession to regain control. Given this history, officials will be hesitant to stop tightening until they’re highly confident (probability greater than 80%) that they’ve done enough — that the labor market has sufficient slack to keep inflation low and stable, and that easing financial conditions won’t lead to a inflation rebound.”
Powell then rubberstamped this definition with his Jackson Hole speech, defining “confidence” as:
A sustained period of below-trend growth
Very likely some softening of labor market conditions
Maintaining a restrictive policy stance for some time (i.e. “higher for longer”)
The Fed is clearly taking a “weight of the evidence” approach to determining whether it has done enough to bring inflation back to 2% on a sustained basis, and given the hawkish shift that’s occurred since June, it’s clear that since Jackson Hole 2022 not nearly enough evidence has accumulated for the Fed to back down anywhere close to the extent consensus believes it can and will.
Weighing the Confidence Evidence
Growth has not stayed below trend by enough for long enough for the Fed to be confident the job is done. And in fact, growth appears to be reaccelerating, underscoring the risk the Fed could ultimately have to hike Fed Funds to above 600 bps.
The Speech: Look for Powell to reiterate the critical importance of an extended period of below trend growth to ensure the economy has returned to proper balance.
Softer Labor Market Conditions
Job openings and wage growth have softened since last Jackson Hole, leading many to suggest the Fed has seen the “softening of labor market conditions” Powell referred to. But it’s clear from recent commentary by FRB New York President John Williams and FRB Minneapolis President Neel Kashkari that the Fed is looking for outright job losses before it is fully confident the job is done. At minimum, the Fed needs to see the unemployment rate move up to the 4-5% range as projected in the June SEP.
The Speech: Because labor is part of the Fed’s mandate, look for Powell to soft pedal the need to get the unemployment rate up and instead focus on the need to see “recent softening continue”.
“Higher for Longer”
Far and away the most important piece of FED communication since the hawkish policy shift began in June was FRB San Francisco President Mary Daly’s post-July CPI report interview where she provided the most explicit definition to-date of what the Fed means by “confident”. She said in no uncertain terms that for the Fed to be confident that inflation is on its way back to 2% on a sustained basis, it needed to see YoY “supercore” inflation (i.e. core services ex. housing) return to its pre-pandemic average. Barring an economic and financial market accident along the way, only then will the Fed consider normalizing policy.
The Speech: Look for Powell to be explicit in the need to get “supercore” inflation back to the pre-pandemic average before the Fed considers neutralizing policy.