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.”


 

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10 thoughts on “The Scientific Method

  1. As you have pointed out many times over the years, Econimics is a soft science, but I am sure that there is a Phd formula that is 6 inches long that tries to determine when inflation becomes entrenched.

  2. The stage is set up for re-testing recent lows this Friday on another hot jobs number, the Q&A had a “long way from neutral” feeling to it, might result in another December to remember.

    1. Yeah, I think he got the idea he was coming across as overly dovish, when in fact the market was prepared to trade it pretty flat — right up until he started to get emphatic. I’m not sure the nod to terminal being higher than the September dot plot was that big a deal. Terminal pricing was already ~40bps above that anyway. But yeah, he turned what could’ve been flat everything and marginally lower stocks into sharply lower stocks, which is probably fine with the Fed, particularly in light of the recent rally. I think he did ok.

  3. if FED objective in short term is ‘restrictive’ (inflation is fueled in part by sentiment, no?) … way lower stocks is a desirable outcome, to reset sentiment. Maybe he did even better than ok … just not for the pivot hopefuls, e.g., recent equity buyers

    1. Yeah for sure. All I’d say is that generally, what you want to do with these pressers is kinda shake out the knee-jerk reaction across assets, and make it into the close without anything getting too far afield, that way the market can sit with it for at least a few hours and then trade it “correctly,” as opposed to emotionally. The risk here, for example, is that Wednesday’s selloff turns into Thursday’s reversal, particularly if you get a bunch of downside monetization first thing in the morning and people start playing for upside via short-dated options. Then of course Friday is a wild card with NFP. I think what he’d rather see is a slow bleed in equities over several days that reverses this recent rally, while rates and the dollar tread water. What he’s got now is a pretty sizable selloff coming out of that presser, which means — you know — anything can happen, especially considering that the market already had the terminal rate at 5%. So, really, that’s not new and the step-down was confirmed. Traders could easily rationalize a risk-on rethink with that. The “rational” thing is stocks lower again Thursday, but these aren’t rational markets. The BoE is on deck too. That could go any number of ways.

      1. Much appreciate this comment, H. Thanks for your perspective of the nuance and implications of the Fed’s actions.

        I’m not keen on Powell’s style and messaging. My choice would have been Mary Daly when the Fed chair opened up.

  4. In this current populist moment, it’s easy to bash CBers, and maybe especially Jerome Powell, head of the most important CB in the world. That said, I’d invite Mr. Powell into my foxhole any day of the week.

  5. My takeaways
    1. May or may not shift to smaller hikes in Dec (so 50 or 75 on table), then hikes (smaller) to continue in 2023 with no clear end date (very premature to think about pausing)
    2. Terminal rate is moving up (I’d think should go at least 50 bp higher, now is only 100 bp above current FF)
    3. Fed wants to force housing prices, stock prices, labor market all down
    4. Fed confident it can fix things if over-tighten, less confident it can fix things if under-tighten
    5. Fed sees no real progress made on inflation, labor market (not willing to forecast inflation slowing from falls in ISM, topping JOLTS, etc)
    6. While some FOMC members may be worried about over-tightening (“cumulative” language), Powell is in the hawkish camp and so far retains control (unanimous decision)

NEWSROOM crewneck & prints