By Chief Economist, Jeanette Garretty
The Federal Open Market Committee (FOMC) decision to keep the Fed Funds rate target at the 5.25%-5.5% was not unexpected, although in the last few days there had been speculation that recent increases in oil and gasoline prices might prompt the Fed to take pre-emptive action against a potential rise in measured inflation. The FOMC statement accompanying the decision made clear that vigilance against future inflation acceleration – or insufficient inflation deceleration—would be maintained and that additional tightening could be possible. However, at present the stance is one of monitoring both short term inflation pressures and the accumulating effect of past interest rates increases. The FOMC seems quite comfortable with this positioning.
Unlike the statement on interest rates, the accompanying Summary of Economic Projections (SEP) demonstrated a number of changes in the committee members’ outlooks for economic growth, unemployment, inflation and the future path of interest rates. Committee members appear to be leaning more clearly towards a softer landing for the US economy, raising economic growth in 2023 and 2024 from the projections made in June, moderating the expected increase in unemployment and maintaining a forecast for inflation slowly declining below 3%. The most sobering aspect of the SEP is the weak economic growth of 1.8% projected for the years beyond 2024; this is no doubt driven by weak labor force growth and productivity that has not accelerated enough to mitigate the demographic realities. It is worth noting that there is a wide range of disparity on the committee members’ projections, both near-term and longer-term and, most interestingly, there was no comment included about the view from the Federal Reserve Research Staff.
Press Conference Commentary
Chairman Powell chose to introduce the concept of “proceeding carefully” with respect to monetary policy right up front, before discussing a US economy that is largely doing better than expected and without the usual cautionary tone about inflation. Headwinds from “tighter credit conditions” were prominently cited as a reason for keeping interest rates at present levels. At the core, Powell’s opening statement was more benign about inflation than at previous press conferences and seemed to offer more caution about the future path of economic growth than in press conferences past.
Unfortunately, an answer to a question from a reporter from the Financial Times questioning the uncertainty about the “sufficient restrictiveness of monetary policy”, was exceedingly confusing and served to undo some of the tone established by Powell at the opening. In the course of attempting an answer, Chairman Powell highlighted that “most” committee members believe that one more interest rate increase this year is likely — but that there are “a number of” committee members who do not believe another interest rate increase is required. Clear as mud and demonstrating a remarkable ability to tank the message before it is delivered (equity markets predictably dropped at exactly this moment). Ultimately, Powell used the question to emphasize what he always emphasizes: the Fed will continue to collect data and make judgements accordingly.
First quote of the day: “There is not a huge importance of one hike in a macroeconomic sense.” This quote was in response to questions about what one more hike in interest rates is likely to achieve in terms of inflation and what the impact might be on economic growth. Further interrogation on this front, i.e. the macroeconomic sensibility of the SEP numbers and the FOMC members’ variety of forecasts, led to a very unsatisfying discussion from an economist’s perspective. The substitution of FOMC member forecasts in place of a macroeconomic modeling that might provide some base guidance capturing the interaction between policy and economic conditions in a very complex economy becomes more and more questionable. At the very end this month’s SEP is an explanation of the level and source of uncertainty around FOMC member forecasts, in sufficient detail to call into serious question what meaning can really be assigned to the SEP forecasts.
Interspersed at various times during the press conference was a quite substantial discussion by reporters of the “natural rate of interest”, otherwise known as R*. Chairman Powell correctly framed the discussion of the natural rate of interest, or neutral rate of interest, as being the contemplation of a highly theoretical and not-directly-calculable concept of limited use in the setting of short-term monetary policy. For further detail on the concept, please see an excellent Market Note by Robertson Stephens advisor Avi Deutsch, “What is a Natural Interest Rate Anyway?”
A number of reporters understandably sought insight into the Fed’s thinking about the current pace of US economic growth, given that Chairman Powell frequently mentioned that the US economy is showing surprising strength and that, in the past, this has been presented as a potential inflation-fighting problem by the Fed. Powell advanced the thought that the current pace of GDP growth is not necessarily a problem for achieving inflation targets. “The real question Is whether the heat we see in GDP really going to be a problem in getting back to 2% inflation.” This would seem to be an argument for scrutinizing minute details of economic activity, but beyond that, his answer was not very clear. The most material implication of the current strength of the US economy is, according to Powell, lesser pressure for rate cuts in 2024 – not because of concern about inflation but because of optimism about economic growth.
Good questions about consumer spending and consumer credit provided Chairman Powell an opportunity to expand upon his own view of the economy. He revealed that he sees most of the current numbers for consumer credit as a return to pre-pandemic levels and not alarming when put into proper context. In further elaboration, he clearly stated that he viewed consumer spending strength as “a good thing” and employment strength as “a good thing.”
Throughout, there was a puzzling confusion that emerged around the concept of a soft landing, and whether a soft landing is 1) a baseline scenario for the Fed and/or 2) a goal for the Fed. Chairman Powell at first said that a soft landing was not a baseline scenario, but then objected when a reporter reflected a view that this meant that the Fed was not seeking to achieve a soft landing. Later in the press conference, Powell recited a litany of economic positives (something he would not have done even a few short months ago) including employment and decelerating inflation, that are consistent with the concept of a soft landing. Indeed, throughout the press conference, Chairman Powell seemed inclined to talk positively about economic growth, wage increases, household balance sheets and progress against inflation, in sharp contrast to previous press conference filled with foreboding about consumer spending, service sector inflation, and unsustainably tight labor markets. The entire press conference had a remarkably different tone, marred only by the communication missteps (this author’s judgement) in the first ten minutes.
The Bottom Line:
- The Federal Reserve is 50/50 on a rate hike in November or December
- It is not clear what a rate hike in November or December will accomplish
- The US economy currently appears to be in soft-landing mode and this makes Chairman Powell happy (but maybe not James Bullard.)
- No one should start thinking about significant interest rate cuts anytime soon
- Very good financial press reporters badly want to discuss economic theory and this is not Chairman Powell’s wheelhouse.
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