Waiting Game

For the second straight day, Jerome Powell spoke in Europe about the outlook for US monetary policy.

“Inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go,” he said in Madrid, repeating, basically verbatim, a set of monotonous talking points markets have now heard five separate times in June.

Thursday’s comments came just hours after he spoke at the ECB’s marquee event in Sintra. “It may be that we don’t move for a meeting and then move at a meeting,” Powell mused. It’s going to be a while before “the full effects of monetary restraint” manifest, “especially on inflation.”

Someone asked if it was possible inflation might never go back to 2%. Powell conceded it could be a “good while” before the US sees 2% inflation again. No one should assume a return to the low inflation environment, he cautioned. After all, “we’ve all seen” how stubborn it can be once it’s a semblance of entrenched.

To his credit, Powell is earnest and he tries to be honest. I don’t think that serves him especially well (this isn’t a world that rewards honesty, and monetary policy is a profession that demands an almost pathological commitment to hubris), but officials do need to be very cautious about the idea that if we just wait around long enough, this will all work itself out.

Again and again, it comes back to the same question: Are we, or are we not, in Kansas anymore? It’s occurred to me recently that the Toto reference might be lost on a majority of readers. If Judy Garland were alive, she’d be 101 this month. The Great Moderation reference isn’t especially poignant either. I’m sure it’s paramount in PhD programs for economists, but it’s not something that’s prioritized in business school (it’s better that students should read another case study, I suppose).

Suffice to say central banks are clinging, desperately on some days, to the idea that we still live in a world defined by disinflation attributable to a handful of familiar dynamics — namely, debt, demographics and disruption. Certainly, there’s been a lot of “disruption” in the 2020s. But it’s been of the inflationary variety. And so far anyway, rate hikes haven’t done much to ameliorate price pressures. Nevertheless, r-star is lower, we’re told.

It’s somewhat encouraging that Powell (and, to a degree, Christine Lagarde) come across as receptive to the idea that there’s a problem which may not go away despite their best efforts. But overall, I still find the discourse around the idea of a “hot world” to be generally arrogant, smug and dismissive, as though we haven’t just seen what we’ve all just seen.

There was some incrementally good news on Thursday. A measure of consumer inflation expectations in the eurozone fell to the lowest since Q1 of 2016.

Inflation data out of Spain and Italy was somewhat encouraging. Headline price growth in Spain was just 1.6% in June, but it’s going to rise anew once the base effects wane, and core is still running near 6%. In Italy, 6.7% on the headline gauge counted as a 14-month low. Regional data out of Germany was less encouraging. Nationally, headline German inflation rose 6.4% in June YoY (6.8% on the harmonized gauge), a re-acceleration from the prior month’s pace.

Coming quickly back to Powell and the US, if we assume that the world hasn’t changed, then it’s a waiting game. And also a game of chicken with the labor market.

“All the Fed needs to achieve over the next 12 months is to avoid a dramatic shift in growth/employment while waiting out the stickier aspects of the inflation complex,” BMO’s Ian Lyngen and Ben Jeffery wrote Thursday. “The trajectory of core-services ex-shelter will be essential in the Fed’s assessment of its own success,” they added. “What’s less obvious is how the market will react to evidence the pace of hiring is finally responding to the prior tightening.”