For today’s Data discussion we’ll put some graphs around Fed Chair Jay Powell’s most notable comments at today’s post-FOMC press conference:
#1: Powell sees the last decade as one where the Federal Reserve failed to achieve its mandate of sustained 2 percent core inflation, and the data supports that assessment. The following chart shows core PCE inflation (the Fed’s preferred measure) over the last 10 years. The times where the US economy managed to show 2 percent inflation are limited to brief stints in 2012 and 2018. Aside from those periods, core PCE has generally run closer to 1.5 percent.
Takeaway: Chair Powell cited Europe and Japan as cautionary stories of what happens when central banks lose credibility on inflation targeting, and he clearly sees the post-pandemic period as a chance to reset the Fed’s relationship with markets and consumers on this issue. Fed policy in 2021 and 2022 is not just about helping the US economy recover; it is about finally fixing what it sees as a long run problem.
#2: No surprise, then, that Chair Powell welcomes the idea that Americans’ inflation expectations are rising. He mentioned the NY Fed’s consumer survey of 3-year forward inflation expectations, so let’s look at that:
Takeaway: consumer expectations for sustainable (i.e., 3-year forward) inflation are definitely rising but are not yet back to the highs of mid-2013 (3.8 pct). What happened after 2013 – that long slide lower through 2019 – is what the Fed wants to avoid in the 2020s.
#3: Shifting gears to the US labor market, where many press questions centered on American labor force participation (LFP). This is the percentage of the population over 18 years old that is either looking for work or employed. Here is US LFP back to 2000:
Takeaway (1): while the Fed has not historically focused much on labor force participation, it is now an important policy consideration. Why? They see it as a valid measure of how far down an economic expansion reaches into various socioeconomic strata. Participation rates vary widely by educational attainment, for example, with college-educated worker LFP presently at 73 percent but only 56 pct for workers who finished their education with a high school diploma. Just before the pandemic hit college LFP was the same as now, but high school LFP was 2 points higher.
Takeaway (2): as with the inflation issue, the Fed’s focus on getting LFP back to pre-pandemic levels (2 points higher than now) means keeping rates lower for longer than required to simply nudge the US economy back to growth. It takes a very hot economy to pull marginal workers back into the labor force, both from the demand and supply side of the equation. LFP, however, is just as much a demographic issue as an economic one. The Fed won’t know if it has done all it can do on this front for potentially years to come.
#4: The most notable change in the Fed’s new Summary of Economic Projections was an increase in the Fed Funds rate for 2023 versus the March SEP, from 0.1 percent then to 0.6 pct now. That’s the equivalent of 2 quarter-point moves some time during that year.
Unlike many Fed projections, markets actually took this message to heart; 2-year Treasury yields broke out to 12-month highs today, as this chart from CNBC shows:
Takeaway: while “liftoff” (Powell’s verbal shorthand for raising rates) may be 2 years away, capital markets started the countdown clock today. For readers who remember the 1994 rate cycle and stock market selloff, that will be concerning. While we’re still fundamentally positive on US equities because earnings estimates are way too low, the move in 2-years supports our idea that one wants to be reducing risk here and looking for better prices before reloading.
#5: Powell knows the 2013 “Taper Tantrum” was not about tapering per se, but rather about then-Chair Bernanke single-handedly flubbing the Fed’s communication on the topic. It all happened at a May 22nd congressional appearance, when Bernanke hinted at slowing the pace of bond purchases “if we see continued improvement and we have confidence that that’s going to be sustained.” Months of press conferences and Fed comments couldn’t put that cat back in the bag.
This is what happened in 2013 and 2014: “tantrum” in 2013 (ending right in the middle of the chart, peaking at 3.0 pct), and then lower yields once tapering actually started in 2014.
Takeaway: this is why Powell is so careful on the tapering topic. We expect the Fed to telegraph its intentions months before any actual reduction in bond purchases.
Summary: the Fed put the timing of a rate hike cycle back on the market’s front burner today, even if any eventual liftoff is still 12-24 months away.