Discussion
In my Jackson Hole 2023 preview below, I said I anticipated three things from Powell:
He would look to build on his closing message from last year by weighing the “confidence” evidence that has accumulated since Jackson Hole 2022
Provide the following assessment of said evidence: 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
Speak with a dovish tone in order to manage the financial conditions tightening that was likely to ensue in the wake of a hawkish speech
(1) & (3): Not only did Powell build on his Jackson Hole 2022 speech with a robust assessment of “confidence” evidence, he led off the speech with the following hawkish screech:
“At last year’s Jackson Hole symposium I delivered a brief, direct message. My remarks this year will be a bit longer, but the message is the same. It is the Fed’s job to bring inflation down to our 2% goal. And we will do so.”
This screech set the tone for the overall speech, and I’m honestly shocked at how hawkish he was given the market narrative leading up to today was that he wanted to “calm markets”. As I said on Xwitter, he was far more hawkish on the labor market than I thought he would be, and he never once mentioned a soft landing. Very little was dovish about today - at best the doves got an entirely asymmetric reaction function forecast: “…we will proceed carefully, as we decide to tighten further or instead to hold the policy rate constant and await further data.”
#2: Weighing the Confidence Evidence
Below-Trend Growth
“…we are attentive to signs that the economy may not be cooling as expected. So far this year, GDP growth has come in above expectations and above its longer-run trend. And recent readings on consumer spending have been especially robust. In addition, after decelerating sharply over the last 18 months, the housing sector is showing signs of picking back up. Additional evidence of persistently above-trend growth could put further progress on inflation at risk, and could warrant further tightening of monetary policy.”
Bullard already told us where Fed Funds is headed in the event this “additional evidence” is accumulated: 600 bps. Let’s see if the economy and financial system allow the Fed to get there…
Softer Labor Market Conditions
“We expect…labor market rebalancing to continue. Evidence that the tightness in the labor market is no longer easing could also call for a monetary policy response.”
Given the fall in job openings and deceleration in wage growth, I am very surprised he called out the labor market as a section of the economy that could induce the Fed to tighten further. I just thought that since the labor market is part of the dual mandate that he would leave it alone and focus his attention on aggregate demand and inflation. Nope. A very hawkish call-out (in addition to calling out the housing market as well, I might add).
“Higher for Longer” Rate Policy
Based on Mary Daly’s guidance that the Fed is unlikely to consider rate cuts until nonhousing core services inflation returns to its pre-pandemic average on a YoY basis, I thought Powell would home in on this metric specifically in order to underwrite “higher for longer” pricing in the rates market. Instead, he broke core PCE inflation into three buckets (goods, housing services, and nonhousing services) and called out goods and housing services inflation as needing to return to their pre-pandemic levels to ensure inflation was on a sustained path to 2% inflation. On nonhousing services specifically he said:
“Given the size of this sector [nonhousing services], some further progress here will be essential in restoring price stability. Over time, restrictive monetary policy will help bring aggregate supply and demand back into better balance, reducing inflationary pressures in this key sector.”
At first glance “some further progress” is dovish relative to Mary Daly’s guidance. But the fact he followed it up with a specific focus on aggregate supply and demand is tremendously hawkish, as it widens the bar to rate cuts (macroeconomic focus instead of a specific pre-pandemic average level).
Two Key Highlights
Emphatic Defense of 2%
Far and away the most obvious “moment” of the speech was his emphatic defense of the 2% inflation target. You have to watch the clip to get the full effect (watch the head movement), but below is what he said - directly to the point, Jackson Hole 2022-style:
“Turning to the path forward. 2% is and will remain our inflation target.”
“Over Coming Quarters”
In my opinion, the most important part of the speech was this very sneaky follow-up guidance to his “a full year from now” line from the July FOMC:
“Two months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal. We can’t yet know the extent to which these lower readings will continue, or where underlying inflation will settle over coming quarters.”
Speech Quotes
“At last year’s Jackson Hole symposium I delivered a brief, direct message. My remarks this year will be a bit longer, but the message is the same. It is the Fed’s job to bring inflation down to our 2% goal. And we will do so.”
“We are prepared to raise rates further, if appropriate. And intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down to our objective.”
Inflation Analysis
“Two months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal.”
“We can’t yet know the extent to which these lower readings will continue, or where underlying inflation will settle over coming quarters.”
“12-month core inflation is still elevated, and there is substantial further ground to cover to get back to price stability.”
“On a 12-month basis core goods inflation remains well above its pre-pandemic level. Sustained progress is needed, and restrictive monetary policy is called for to achieve that progress.”
“If market rent growth settles near pre-pandemic levels, housing services inflation should decline toward its pre-pandemic level as well. And we will continue to watch the market rent data closely for a signal of the upside and downside risks to housing services inflation.”
“Given the size of this sector [nonhousing services], some further progress here will be essential in restoring price stability. Over time, restrictive monetary policy will help bring aggregate supply and demand back into better balance, reducing inflationary pressures in this key sector.”
The Economic Outlook
“Although further unwinding of pandemic-related distortions should continue to put some downward pressure on inflation, restrictive monetary policy will likely play an increasingly important role.”
“Getting inflation sustainably back down to 2% is expected to require a period of below-trend economic growth as well as some softening of labor market conditions.”
“Such a tightening of broad financial conditions typically contributes to a slowing in the growth of economic activity, and there is evidence of that in this cycle as well. BUT, we are attentive to signs that the economy may not be cooling as expected. So far this year, GDP growth has come in above expectations and above its longer-run trend. And recent readings on consumer spending have been especially robust. In addition, after decelerating sharply over the last 18 months, the housing sector is showing signs of picking back up. Additional evidence of persistently above-trend growth could put further progress on inflation at risk, and could warrant further tightening of monetary policy.”
“We expect this labor market rebalancing to continue. Evidence that the tightness in the labor market is no longer easing could also call for a monetary policy response.”
The Policy Path Ahead
“Turning to the path forward. 2% is and will remain our inflation target.”
“Real interest rates are now positive and well above mainstream estimates of the neutral policy rate. We see the current stance of policy as restrictive. But we cannot identify with certainty the neutral rate of interest, and thus there is always uncertainty about the precise level of monetary policy restraint.”
“That assessment [of neutral] is further complicated by uncertainty about the duration of the lags with which monetary tightening affects economic activity and especially inflation. The wide range of estimates of these lags suggests there may be significant further drag in the pipeline.”
“As is often the case, we are navigating by the stars under cloudy skies. In such circumstances, risk management considerations are critical. At upcoming meetings, we will assess our progress based on the totality of the data and the evolving outlook and risks. Based on this assessment, we will proceed carefully, as we decide to tighten further or instead to hold the policy rate constant and await further data.”