Jerome Powell’s Jackson Hole speech is out and it in addition to the scenic Wyoming backdrop, his comments are set against turmoil in emerging market assets and harsh words from Donald Trump, who this week took his criticism of Fed policy up several notches, going so far as to tell Reuters that he expects the Fed to “do what’s good for the country”.
For the President, “what’s good for the country” is the Fed taking a pause on rate hikes in the interest of pushing the dollar lower.
Powell has been steadfast in his upbeat assessment of the U.S. economy and as we never tire of reminding folks, the irony here is that the reason the Fed has to lean so overtly hawkish is down to the prospect that late-cycle fiscal stimulus pushes up inflation. Trump’s trade war also has the potential to drive up domestic prices, especially in the next round of 301-related tariffs which will hit consumer items.
Trump’s comments sent the dollar lower in four out of five sessions this week, a blow to crowded positioning. In the week through last Tuesday, USD net longs jumped another $1.4 billion to a new fresh “since January 2017” high at $24.3 billion overall.
Meanwhile, the curve continues to flatten and the spec short in the long-end of the curve is further evidence that the market is inclined to believe Powell will be reluctant to bow to pressure from the White House. Some Fed officials pushed back on Trump this week (more on that here).
Powell has an opportunity to strike something of a middle ground if he so chooses. He could move ahead with the fully priced September hike but package it in a dovish wrapper predicated on the turmoil in international markets. The Fed minutes, out Wednesday, did contain some brief allusions to that turmoil.
In any event, the text of Powell’s speech in Jackson Hole finds the Fed chair noting that gradual rate hikes are the best strategy when it comes to navigating the Scylla and Charybdis of doing too much (i.e., hiking the economy into recession) or doing too little (i.e., risking an overheat). Obviously, the chances of an overheat increased when Trump decided to pile fiscal stimulus atop an economy operating at or near full employment.
“I see the current path of gradually raising interest rates as the FOMC’s approach to taking seriously both of these risks,” Powell says, adding that “with solid household and business confidence, healthy levels of job creation, rising incomes, and fiscal stimulus arriving, there is good reason to expect that this strong performance will continue”.
Right. But the problem with that for Trump is that he (the President) wants to have his cake and eat it too. He wants to hold press conferences in front of the White House to celebrate quarterly GDP data, but he doesn’t want the Fed to acknowledge the strength inherent in that same data by gradually hiking rates.
The literature on structural uncertainty suggests some broader insights. This literature started with the work of William Brainard and the well-known Brainard principle, which recommends that when you are uncertain about the effects of your actions, you should move conservatively. In other words, when unsure of the potency of a medicine, start with a somewhat smaller dose. As Brainard made clear, this is not a universal truth, and recent research highlights two particularly important cases in which doing too little comes with higher costs than doing too much. The first case is when attempting to avoid severely adverse events such as a financial crisis or an extended period with interest rates at the effective lower bound.
In such situations, the famous words “We will do whatever it takes” will likely be more effective than “We will take cautious steps toward doing whatever it takes.” The second case is when inflation expectations threaten to become unanchored. If expectations were to begin to drift, the reality or expectation of a weak initial response could exacerbate the problem. I am confident that the FOMC would resolutely “do whatever it takes” should inflation expectations drift materially up or down or should crisis again threaten.
While inflation has recently moved up near 2 percent, we have seen no clear sign of an acceleration above 2 percent, and there does not seem to be an elevated risk of overheating.
This is good news, and we believe that this good news results in part from the ongoing normalization process, which has moved the stance of policy gradually closer to the FOMC’s rough assessment of neutral as the expansion has continued.
As the most recent FOMC statement indicates, if the strong growth in income and jobs continues, further gradual increases in the target range for the federal funds rate will likely be appropriate.
That bit about “no clear sign” of an inflation overshoot seems to skew dovish as does the bit about there not being “an elevated risk of overheating.”
I’m not sure what the point of invoking “whatever it takes” there was, but I’m sure Fed watchers will have something to offer on it.
“[This is] a touch on the dovish side,” ABN Amro’s Georgette Boele says.
Generally speaking, this seems pretty balanced, though. I’m not sure there’s a ton in here that’s going to shift the narrative either way, although the knee-jerk reaction from markets was clearly dovish as the dollar and yields fell. That’s probably down to folks just being happy to have this over and done with.