The Scientific Method

Jerome Powell almost threaded the needle on Wednesday.

Around 20 minutes into one of the most closely watched press conferences of Powell’s tenure, major assets had round-tripped their knee-jerk reactions to the new FOMC statement, which included a nod to a possible reduction in the pace of rate hikes following this month’s 75bps move, the fourth consecutive three-quarter point increment.

For the most part, Powell managed to come across as broadly neutral vis-à-vis the updated policy language. But, after hewing very closely to the statement and even pulling off a decent impersonation of a PhD economist (something Powell isn’t, for better or worse), he ventured an emphatic “Let me say this” moment, mostly unprompted. “Let me say this” moments are fraught with peril in virtually any context, but particularly for central bankers holding press conferences. You’re already saying a lot in that context, and everyone is already listening pretty closely, so the exhortation for markets to perk up and pay attention is superfluous and raises the stakes around whatever it is you’re about to say. You could just make something up and traders and algos would try to act on it, regardless if it made any sense. (“Let me say this: Purple badgers!”)

In this case, Powell wanted to say it’s “very premature to be thinking about pausing” rate hikes. He was responding to questions from a reporter for the Washington Post, who asked if the Fed was now inclined to put more weight on “long and variable lags” given policy’s assumed proximity to restrictive territory after 375bps of hikes in less than a year. It’s too early, Powell said, to even “think about,” let alone talk about, pausing.

That was, perhaps, his only real misstep on Wednesday. Nobody thinks the Fed is going to pause in December or in February either. In fact, Wall Street recently added hikes to their house Fed calls, and upgraded their terminal rate expectations. Although market pricing does reflect cuts beginning in the back half of next year, terminal rate pricing was back to 5% headed into Wednesday’s decision, reflecting at least another 100bps in additional hikes atop November’s move.

Powell also said that “incoming data since our last meeting suggests [the] ultimate level of interest rates will be higher than previously expected.” The September dot plot suggested a peak of 4.6%, so 5% is probably about right. Stocks closed sharply lower in the US.

By the time he fielded questions from the Post, it was obvious Powell felt he might’ve come across as too dovish early on and was trying to make amends. He’d made it abundantly clear that the odds are indeed skewed towards a 50bps move next month rather than a fifth consecutive 75bps hike.

Asked specifically by Reuters whether the bias is for a downshift next month, Powell presented a three-point framework, which he said helps to “put the pace in the context of [the Fed’s] tightening program.” There are three questions, he said: How fast? How high? How long to remain in restrictive territory?

The Fed clearly moved fast, Powell emphasized. The more important question now is how high the Fed needs to go for policy to be sufficiently restrictive to put inflation on a path back down to 2%. “There’s some ground to cover,” he told Reuters. Speed, he said, is becoming less important than the other two considerations. The time to downshift is coming. He wouldn’t say whether that time is December, but he did suggest it’s either next month or in February. The emphasis on the destination rather than the pace was meant to be hawkish. The Fed needed to tip a potential dial down, and it was left to Powell to make it clear to markets that the focus should be on the higher terminal rate, not the slower pace to get there.

Asked by the Financial Times whether a downshift is contingent on better inflation outcomes, Powell basically said no, albeit while stating the obvious: The end goal is lower inflation and everyone would love to see that happen sooner rather than later. But, he said, he’s “never thought of slower inflation outcomes” as the deciding factor in the pace of hikes. The main goal now, he repeated, is to reach a sufficiently restrictive level on Fed funds. Do note: It’s not realistic to expect materially better realized inflation prints between now and the December FOMC meeting. So, Powell’s answer made a lot more sense than it might seem to the casual observer.

Nick Timiraos was there. He asked if the Fed will ultimately have to raise rates above core PCE. Powell said it’d probably make more sense to use a forward looking measure of inflation, rather than last month’s price data. I’ll make the obvious joke: Forecasts for inflation haven’t exactly proven reliable in the pandemic era. “We do want to get to a place where the real policy rate is positive,” Powell told Timiraos, before noting that the Committee’s pretensions to engineering a positive real policy rate aren’t the “single, dominant” aspiration.

Powell began Wednesday’s proceedings with another adamant expression of “resolve” in the inflation fight. “Without price stability, the economy doesn’t work for anyone,” he said, reiterating what’s become a go-to talking point for the Fed amid concerns that ongoing rate hikes will cost scores of Americans their jobs. Powell was quizzed in caustic terms this week by politicians including Elizabeth Warren, who wondered “How many millions will be thrown out of their jobs from the Fed’s dangerous rate hikes?” (Dangerous hikes from a “dangerous man” for a dangerous world, I suppose.)

“The longer the current inflation continues, the higher the odds it’ll become entrenched,” Powell warned.

Asked by the New York Times if the Fed has “seen any evidence at this stage that inflation is, or is at risk of, becoming entrenched,” Powell pointed to longer-term expectations as relatively anchored, but conceded that very high near-term readings are “concerning” given the potential implications for wage-setting.

While regaling the Times, Powell said, “We don’t have a clearly identified scientific way of understanding when inflation becomes entrenched.”