No Pivot in Jackson Hole

by | Aug 26, 2022 | Blog, Bonds

Powell focused on inflation and the willingness to tolerate “some pain to households and businesses” to bring inflationary pressures down. He also says that it will likely require maintaining a restrictive policy for some time. This is Fedspeak for: 1) rate will keep increasing (we are not yet in restrictive territory) and, 2) rate cuts won’t come as easily or as soon as the market expects.

Powell explicitly references the lesson of the 1970s and 1980s. The messages that he takes away from those are:

  • The Fed needs to take charge and bring inflation down quickly
  • Inflation expectations can’t be allowed to run too high for risk of entrenchment
  • The Fed must “keep at it” until the job is done (no stop and go easing like in the 1970s)


Today was definitely not a pivot.

 

A few notable comments from the speech with Aptus commentary:

 

“If the public expects that inflation will remain low and stable over time, then, absent major shocks, it likely will. Unfortunately, the same is true of expectations of high and volatile inflation. During the 1970s, as inflation climbed, the anticipation of high inflation became entrenched in the economic decision making of households and businesses. The more inflation rose, the more people came to expect it to remain high, and they built that belief into wage and pricing decisions. As former Chairman Paul Volcker put it at the height of the Great Inflation in 1979, “Inflation feeds in part on itself, so part of the job of returning to a more stable and more productive economy must be to break the grip of inflationary expectations.”

“Of course, inflation has just about everyone’s attention right now, which highlights a particular risk today: The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched.”

 


The last 40 years, inflation hasn’t been a problem. Expectations for inflation and the volatility of inflation have remained low. Like Powell commented above, in environments like this, where inflation is expected to stay low, it does indeed, typically remain low. Our fears are more geared toward regarding the longer-term damage from the persistent denial of inflation (by the Fed and Wall Street) while inflation was actually raging higher. Does this misstep lead to a shift in expectations which create a self-fulfilling prophecy of higher and more volatile inflation — a true nightmare for the Fed?

 

“History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting. The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.”

 

Powell showed no signs of pivoting or even thinking about easing rates. Given the loosening of financial conditions over the last 2 months (as the market perceived a Fed pivot was coming), the commentary from Powell likely reverts to tighter conditions.

 

“The U.S. economy is clearly slowing from the historically high growth rates of 2021, which reflected the reopening of the economy following the pandemic recession. While the latest economic data have been mixed, in my view our economy continues to show strong underlying momentum. The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers. Inflation is running well above 2 percent, and high inflation has continued to spread through the economy. While the lower inflation readings for July are welcome, a single month’s improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.”

 

The growth rate post-Covid, given the fiscal and monetary policy, isn’t sustainable. In saying that, even given a slowing in the recent economic data, the underlying economy is still strong. The labor market is too strong. Powell assured us that one weak inflation reading isn’t going to give the Fed room to change course or pivot.  We are assuming he threw this comment in following the markets expectations for a pivot (and the easing of financial conditions since July), desiring to set the record straight.

Last comment: if the Fed is adamant the economy is strong, why would they stop hiking?

 

The Public is Watching… and Dare I say Losing Faith

 

Source: Twitter. @Michigandolf

 

The above comment is from a twitter account we follow (mostly for humor). The gentleman behind the handle is a retail day trader with a fairly sophisticated background. Our point of highlighting the comment is that he is not alone in noticing the forecast errors, and in turn, lack of trust in the Feds’ forecasting capabilities. Given how bad they (and Central Banks globally) proved to be with their inflation call, what is to say they don’t error to the other side this time?

 

Concluding Thoughts

 

Last year’s Jackson Hole speech for Powell proved very hopeful. In hindsight, his forecast that inflation would quickly go away was a really bad call (see this week’s blog post for more commentary). This year’s speech attempted to flip the script. Powell communicated that the Fed is desperately attempting to lower inflation without breaking the economy (at least too terribly bad). With inflation being the main problem the country is facing, Powell reiterated that he and his team at the Fed are a long way from easing policy or cutting interest rates and expect more pain ahead.

 

 

 

Disclosures

 

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