Three thoughts on today’s FOMC meeting and Chair Powell press conference for “Data”:
#1: Powell’s comments reminded us of an important fact that doesn’t get enough attention: the Fed is trying to accomplish 2 very different goals with its monetary policy response to the Pandemic Recession.
- The first is to follow its mandate and do what it can to maximize employment in the context of stable prices.
- The second is to reset market and consumer expectations regarding inflation from the abnormally low levels of the 2010s to something that more closely matches its 2 percent long-run target.
The two goals are distinct, and one could rightly criticize the Fed for using a crisis to solve problems unrelated to the very serious issues it creates. But … “Never let a crisis go to waste” is a longtime Washington DC aphorism and the Fed has clearly embraced it.
For example, Powell mentioned that market-based measures of future inflation expectations are only back to levels consistent with the early 2010s, and this chart of 5- and 10-year TIPS implied inflation shows he is correct on that point. Current levels of 2.3 – 2.4 percent are similar to 2013. The broader point he made was that the long stretches of sub-2.0 percent inflation expectations (2015 – 2019) were signs that the market did not believe the Fed could consistently reach its 2 percent inflation objective. That’s what he’s focused on “fixing” now.
While not entirely dismissing concerns about how US consumers see inflation just now, he did caution that measures like the NY Fed Survey of Consumer Expectations has a short track record. Again, that’s true, as the chart below shows; the data only goes back to mid 2013. What Powell did not say (but we will) is that this survey shows consumers consistently guess high on future inflation. He did, however, point out that 1-year expectations (5.2 pct) are higher than 3-year expectations (4.0 pct) and in his opinion that shows consumers see current inflation as more temporary than permanent.
Takeaway: it is totally reasonable to say that the Federal Reserve generally and Chair Powell specifically tend to sound too dismissive of current inflationary trends present in the US economy, but that is certainly consistent with their desire to reset market and consumer expectations. Now, using the pandemic shock to solve an unrelated structural problem is not to everyone’s liking and that’s a fair criticism in our view. Still, markets are thus far unconcerned that this strategy will backfire. We think that’s also fair, if only because the US economy has a much longer track record of lower rather than higher inflation.
#2: Unless the US economy goes horribly awry in the next few months, bond purchase tapering is now a fait accompli so markets will turn their attention to an eventual Fed Funds rate liftoff. The “dot plot” of FOMC members’ expectations for future policy did show more participants inclined to increase rates next year (3 at 2 rate hikes, 6 at one, 9 at no increase).
Markets took that message to heart. The image below is the CME FedWatch tool’s probabilities for different rate scenarios in December 2022, taken just before the NY stock market close today. The odds of at least 1 rate hike next year increased from 55 percent yesterday to 63 percent today. The largest shift in these probabilities occurred in the “2 rate hike” scenario, which went from 14 percent yesterday to 19 percent today.
Takeaway: today’s FOMC meeting essentially took the odds of a 2022 rate hike back to before Chair Powell gave his dovish Jackson Hole speech (compared rightmost column, August 20th, to today). As such, the “dots” didn’t really say anything that markets haven’t already known for over a month. The US economy continues to improve, and the Fed will likely raise rates next year. History shows that the first rate hike rarely kills equity market rallies, so on its own this is not worrisome.
#3: Two non-policy related topics caught our attention:
- Powell is clearly upset about the trading activity of regional presidents Kaplan and Rosengren. By “upset” we mean that his demeanor when answering press questions about the issue (there were 3) resembled someone who would fire these individuals tomorrow if he could.
From a market standpoint, the only reason this issue matters is if it reduces the possibility that Powell will be renominated. PredictIt odds of his seeing another term as Chair remain high at 75 percent, but that’s down from 90 pct before these problems came to light.
- Our friend Jeff Cox of CNBC managed to get 2 questions in about the Fed’s plans for a central bank digital currency at the very end of the Chair press conference. Powell said a discussion paper will be out soon, but said the bar for establishing a US CBDC is “are there clear and tangible benefits?” He also said that he believed both the current administration and Congress would need to approve whatever the Fed might create in terms of a CBDC.
Translation (at least to our ears): no US CBDC is coming for many, many years.
Takeaway: the Federal Reserve is a slow moving, bureaucratic organization and most of the times that is an asset, but sometimes it is also a liability. Fixing PR problems and addressing technological disruption are two issues that fall solidly into the second bucket.