The Fed Keeps Proving Critics Right

I try to give technocratic policymakers the benefit of the doubt. I really do.

For one thing, most Fed officials could be making more money in the private sector. Indeed, some people at the Fed already did make more money in the private sector. While the specifics obviously vary from official to official, it’s safe to say that by and large, spending one’s career in public service isn’t indicative of a desire to maximize one’s lifetime earnings potential. Generally speaking: To go into public service is to take a pay cut.

Beyond that, Fed officials aren’t bereft in the intellect department. Powell isn’t a professional economist, but his colleagues are. Think about what econometricians do: They bend math for a purpose it wasn’t intended. They force math to accommodate a soft science (economics). That’s a dubious exercise, but it’s no small feat. It’s hard, mostly because it’s impossible. I joked about this last month. Penning peer-reviewed journal articles in the era of mathematized soft sciences is tedious to the point of what non-academics might describe as insanity. Economists are a lot of things (sometimes out of touch, frequently wrong about the economy, and so on), but unintelligent isn’t one of them.

All of that said, there are weeks during which Fed officials stumble, inadvertently, into what might as well be a slapstick routine, last week being just the latest example. Maybe there were good reasons why November 30 was chosen as the day for a key speech about the nexus between monetary policy, wage-setting, price growth and jobs. But in an environment characterized by acute angst around generationally high inflation blamed increasingly on the persistence of elevated wage growth, delivering a speech called “Inflation and the Labor Market” is risky if you’re the Fed Chair and you don’t know what a jobs report due less than 48 hours later is going to say about wages.

That’s especially true when, thanks to a two-month rally in stock prices and the worst month for the US dollar in a dozen years, real-time measures of financial conditions had eased such that, from a holistic perspective (i.e., not just myopically focusing on Fed funds), the entirety of the tightening impulse achieved over the preceding several months was in jeopardy.

Additionally (and this is crucial), market participants spent most of 2022 pressing bets on tighter financial conditions, whether in dollar longs or shorts in rates and equities. Those positions are (still) vulnerable to violent reversals, which means you have to be careful not to give anyone an inch, lest the ensuing price action should trigger stop-outs and force-ins, that might quickly amount to a mile.

In short: Powell should’ve thought twice about last week’s speech. And if he still thought it was a good idea, he should’ve thought three times.

Importantly, this particular mistake of Powell’s wasn’t attributable to his poor track record as an ad hoc communicator. His tenure is replete with examples of communications faux pas that Janet Yellen wouldn’t have committed on a bad day, but this wasn’t that. These were prepared remarks, which makes the situation more concerning because presumably, other Fed officials read them ahead of time. At the least, someone else read them, which means it wasn’t just the Fed Chair who failed to predict that those remarks — delivered in the current environment, flying blind vis-à-vis a monthly jobs report due 36 hours later — were perilous, but rather the Fed Chair plus a few people.

That, I’d argue, is inexcusable to the extent Powell didn’t mean to trigger the third-largest financial conditions easing impulse of the current tightening cycle. I’m compelled to illustrate the point again (figure below).

Note that the easing which accompanied the cooler-than-expected October CPI report (annotated on the chart with Powell’s speech) was the largest single-session impulse on record.

To be clear: Powell almost surely intended to deliver a more balanced speech than he did in Jackson Hole. But he still seems insufficiently attuned to market dynamics.

This makes it difficult for otherwise generous people like myself to defend Powell and his colleagues against critics. Critics like Larry Summers, Bill Dudley and Mohamed El-Erian, all of whom have been proven correct time and again, not because they’re fortune tellers, but because the Fed continues to commit unforced errors.

It doesn’t help that the “transitory” crowd (and those predisposed to looser policy in general) often seem reluctant to concede reality. I thought I was woefully late in abandoning the “transitory” narrative, but almost a year later, with all manner of very serious people still clinging to some version of it, my early February capitulation almost looks prescient. Or as prescient as something that was late can be.

In the wake of Friday’s jobs report, El-Erian critiqued Powell’s Brookings speech. “[Powell] did a few things that made the market hear just what it wanted to hear,” he told Bloomberg’s morning programming, before elaborating:

First, confirm that we are downshifting in December. Second, do this ahead of the labor report suggesting that [maybe] he knew something others did not know. Third, talk about risks being now balanced and two-sided. And then what he didn’t mention. He did not push back in any way on what already was a significant rally in markets and a significant loosening in financial conditions. So, while he said other things and he was right to say other things… he didn’t realize where the technicals of this marketplace were. He didn’t realize the behavioral aspects. And that’s why you got this overreaction.

That’s precisely correct. That excerpted passage from El-Erian’s remarks is a short version of everything detailed above.

Note especially El-Erian’s reference to the proximity of November payrolls. In my week ahead preview on November 27, I suggested it was risky for Powell to talk about the labor market during NFP week. Specifically, I wrote that,

Powell will editorialize in real-time about the jobs market during jobs week. I suppose you could suggest that’s helpful. I’d be more inclined to say it’s just as likely to cause confusion.

My (tacit) warning was on target. There was indeed some confusion by the end of the week.

On December 1, following Powell’s speech, El-Erian penned what he described as a “hypothetical, tongue-in-cheek conversation between Powell and markets,” which included the following exchange:

Markets: What we noticed is that you told us you are downshifting on rate hikes before the publication of Friday’s jobs report. You obviously feel strongly about this.

Powell: Wait…

If you haven’t read El-Erian’s latest, it’s worth your time. You can find it in full here.


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