The FED: A Hawkish Mary Daly
Not Volcker 20% rates and double-digit unemployment hawkish - but hawkish against the backdrop of a financial market looking for an easing of policy at the first hint of labor market weakness.
Discussion
Since the Fed launched its war on inflation in earnest in March 2022, FRB San Francisco President Mary Daly has been a key communication vehicle for the median FOMC view of monetary policy. In the lead-up to Jackson Hole 2022 she was a key member of the contingent pushing back against financial markets’ dovish interpretation of Chair Powell’s July 2022 FOMC press conference (see here and here), and most consequentially, last August she outlined in specific detail that the Fed needs to see supercore inflation return to pre-pandemic levels in order to be sufficiently “confident” that inflation is on a durable path back to 2%. So, when Daly speaks, you listen.
Daly’s interview last week with David Beckworth of the Mercatus Center was released early this morning, and while there was a high-level read-out of the interview provided last week the full interview contained detail worth delving into.
Current State of Monetary Policy
The “confidence bands” around the projected path of inflation have widened over the last three months after narrowing over the course of 2H23
“There’s considerable…uncertainty about what the next few months of inflation will be and what we should do in response.”
Scenario 1: “…a scenario that would be a very nice scenario is that inflation got a little bit of a slow start, but it continues to come down, because the labor market is starting to slow, the economy's slowing. We see a continuation of what we saw during the second half of last year. If that happens, then, of course, starting to normalize the policy rate would be appropriate.”
Scenario 2: “But if we get a different scenario where inflation stays level, just doesn't make much further progress, then it's not appropriate to start adjusting the rate unless we see the labor market faltering, which it's not showing any signs of doing.”
Question: “What are your thoughts on that [QT tapering]? Does that signal anything about the stance of monetary policy?”
Answer: “No. Hard No. No signal about the stance of monetary policy.”
And then we get to the core of why I’m even bothering to write-up Daly’s comments: the labor market. In her comments she sounds very similar to Powell, which is why she’s such a good representative of the median FOMC view. Like Powell, she wraps hawkish commentary in a dovish “soft landing” blanket, so you need to read/listen carefully.
Now, right now, I don't see any evidence that the labor market is approaching a worrisome position, but we did see initial claims rise today. We saw the labor market report come in weaker than expectations, still strong relative to what people think is the steady-state level of job growth. There is evidence already out there that firms are a little more picky about hiring, and many firms— especially in tech, for instance, which is dominant in the west— they're rebalancing their portfolios of employees. And so that's something we have to watch. But, today, no, I see a really healthy labor market where people who want a job can get one. What I see is that we still have inflation too high, and that's creating some uncertainty for people about, are we really going to bring it down? And the main message there is, absolutely, over time, down to 2% is our goal. We're resolute to keep it.
Financial markets go all-in on the “but we did see initial claims rise today” statement while completely ignoring the rest:
“I don’t see any evidence that the labor market is approaching a worrisome position.”
The labor market is “still strong relative to what people think is the steady-state level of job growth.”
And most importantly: “What I see is that we still have inflation too high, and that's creating some uncertainty for people about, are we really going to bring it down?”
This is hawkish commentary, and the hawkishness of it is confirmed by the detail she provides to questions from the media in the Q&A…
Daly Confirms Bostic
The Fed can pretend all it wants that FOMC members do not coordinate their message, but there is no question that it is coordinated. As discussed this weekend, FRB Atlanta President Raphael Bostic put out a specific level of labor market growth that the Fed views as steady-state: “low 100,000 range.” In her answer to Marketplace reporter’s question about cutting rates in response to a weakening labor market, Daly got even more specific: 110,000 to 120,000. This is no accident - the Fed is very clearly pushing back against financial market exuberance over the below-expectations April NFP report. Full answer below:
So, the way I would put it— it's a great question, an important question. The way I would put it is that there's a difference in getting softer and being weak. If the labor market starts to falter or looks like it's getting weak, well, then, absolutely that's one of the things that would cause me to say that we need to rebalance the policy rate as long as we're not seeing inflation skyrocketing. Those are tradeoff decisions, so I don't want to work in the exact – I don't want to lay out a matrix of hypotheticals and tell you exactly what would be done on anything, because we haven't faced that situation.
But I think there is a real conversation to be had here on your question of— a softening labor market, right now, would just be getting back to what we think is normal growth, right? We can have a view that 110,000, 120,000 jobs a month is what the economy can absorb at any one time. We're outgrowing that even with the slightly softer or below-expectations report we had last Friday. And so, you do see it cooling, but that's what we should expect to see, right? The policy rate's high. We're trying to bring the economy back into a more sustainable growth path, whether that's GDP growth or the labor market, and we want to bring inflation down. But the very most important thing to remember is that we have two mandates, price stability and full employment. And right now, we have a strong and healthy labor market, but [we] absolutely have to keep an eye on that [and] continue to watch. So, I'd say that the recent readings, I have my eye on it, but I'm not yet worried.
Hawkish. Full stop. No, not Volcker 20% rates and double-digit unemployment hawkish - but hawkish against the backdrop of a financial market looking for an easing of policy at the first hint of labor market weakness now that it’s clear inflation is stuck at 3%.
Daly Confirms Kashkari
Again, in her own Powell-like way of wrapping hawkish commentary in a dovish “soft landing” blanket, Daly pushed back against post-April NFP financial conditions easing in response to a question from a Bloomberg reporter:
…one of the jobs of the Fed— and I take this part of the job seriously— is that we have to stay steady in the boat, right? There were many who got, I think, overly optimistic on the inflation front with the second half of last year when inflation was falling pretty rapidly. That proved to not be a durable decline, and so that steady in the boat proved to be helpful. Right now, we've got two pieces of labor market information that look below expectations, but not especially weak. And so, we absolutely have to continue to watch that, but I think it's far too early to declare that the labor market is fragile or faltering. We just have to continue to watch.
…I think that this steady in the boat approach is the right one.
…sometimes markets, et cetera, can over and under react to information, in a way that we might just stay smoother in that.
The fact Daly, who is always dovishly laser-focused on the labor market, is hawkish on labor and pushing back against financial markets is a very big deal.
The Bottom Line?
Hide your assets and hug your cash and shorts.