Since the June FOMC meeting, the outlook for monetary policy did not change significantly. The incoming U.S. economic data continued to indicate that the economy has considerable momentum and that the labor market is tight. In various public remarks, Chairman Powell emphasized that the economy is “in a good place.” Trade policy continued to dominate discussions of the economic outlook, as the risk of a major escalation appeared to increase following the June FOMC meeting and as various interest groups voiced increasing concern about the negative impact of restrictive trade policies. Chairman Powell gave his semiannual testimony on monetary policy before the House and Senate oversight committees, stressing that the outlook was strong and that the data to that point did not show evidence of trade developments impacting growth substantially (see our commentaries on Day 1 and Day 2). He warned that there could be negative consequences, however, if the Administration’s stated goal of reducing tariffs and other barriers to trade were not ultimately achieved. His testimony did not substantially change our views on the outlook for monetary policy, but he did provide a few notable remarks, specifically on his views of the implications of the shape of the yield curve and on the risks to the inflation outlook. Shortly after Powell’s testimony, President Trump criticized the FOMC’s ongoing removal of monetary accommodation in an interview, but we don’t see such criticism as having any influence on the FOMC (see our commentary).
Soon after the June FOMC meeting, Chairman Powell gave a high-profile speech (see our commentary) in which he expanded on some of the themes that were apparent in his post-meeting press conference (6/20). He noted that the argument for continuing with a gradual pace of rate hike remains “strong and broadly supported” at this point, but he emphasized how great the uncertainty is around estimates of equilibrium levels of key economic variables, particularly the NAIRU. While the unemployment rate is very low compared to historical levels, he said, “Unfortunately, with the passage of a half-century and important changes in the structure of our economy and in central bank practices, in my view, the historical comparison does not shed as much light as we might have hoped.” Two such changes he cited were increases in educational attainment, which tend to lower the NAIRU because “more highly educated people are less likely to be unemployed,” and
better-anchored inflation expectations. He once again referenced the flatness of the Phillip curve, which makes it much more difficult to estimate the level of the NAIRU. It also suggests that the effect on inflation of a substantial undershooting of the NAIRU “might not be large,” but he warned against trying to exploit this relationship, which would risk inflation expectations becoming unanchored.
While Powell devoted most of his speech to the labor market, inflation, and the relationship between the two, he turned to the topic of financial stability, and we saw his remarks as quite telling. In particular, it’s clear that Powell sees monitoring financial imbalances and vulnerabilities as critical to sound monetary policy. He said: “The fact that the two most recent U.S. recessions stemmed principally from financial imbalances, not high inflation, highlights the importance of closely monitoring financial conditions.” However, he reiterated that “Today I see U.S. financial stability vulnerabilities as moderate and broadly in line with their long-run averages.”
Chairman Powell later appeared before House and Senate oversight committees as part of the semiannual monetary policy testimony. His prepared remarks were consistent with his recent comments, including those in an interview shortly before the testimony. His choice to include the qualifying phrase “for now” in his description of the FOMC’s expectation that further gradual rate hikes are likely to be appropriate drew a lot of attention (6/17). In particular, there was speculation that this wording could appear in the FOMC’s postmeeting statement. We don’t read much into this wording, however. It appears to be another instance of Powell emphasizing the highly uncertain nature of the path of the economy and monetary policy, not a signal of a change in views.
At the two hearings, Powell reiterated the economic outlook is strong and that there is a strong case for further gradual rate hikes. He was asked frequently about trade policy and refused to say whether he approved of the Trump Administration’s strategy of achieving its stated goal of lower barriers to trade: “If it results in lower tariffs for everyone, that would be a good thing for the economy. If it results in broader, higher tariffs across a broad range of traded goods and services that remain that way for a longer period of time, that will be bad for our economy and for other economies, too.” He noted that the data aren’t showing any clear impact from trade, but that “we have heard a rising chorus of concern which now begins to speak of actual capex plans being put on ice for the time being.”
While Powell’s remarks in his testimony didn’t include any great surprises, there were a couple of notable developments. He was asked about the risks to inflation, saying, “I would say it’s roughly balanced.” But he then appeared to provide some rare insight into his personal views on the outlook, suggesting he still sees the risks to the downside: “I think maybe slightly more worried about lower inflation still. But I think, for a long time, inflation was below target, and we were pushing it. Now it’s just about reached the symmetric 2 percent objective.” Another area in which he shared his views was the yield curve. His comments strongly suggested that he is part of the consensus that there isn’t a reason to be greatly concerned about the shape of the yield curve is a strong recession signal. He looks at the yield curve primarily for information on what the neutral rate is: “I think what really matters is what the neutral rate of interest is. And I think people look at the shape of the curve because they think that there is a message in longer-run rates, which reflect many things, but that longer-run rates also tell us something, along with other things, about what the longer-run neutral rate is. That’s really, I think, why the slope of the yield curve matters. So I look directly at that.”
Other policymakers also drew attention to increasing concerns about trade policy, but, like Powell, they were still hesitant to adjust their baseline outlooks. President Kaplan (7/13), said, “What’s going on in the short-run certainly isn’t positive, but for me, it isn’t sufficient yet – yet – to materially change my outlook.” President Bullard (6/28) expressed greater alarm, saying he’d heard “full-throated angst” over trade. He saw the uncertainty affecting business spending and saw the prospect of tariffs leading to higher prices among suppliers already. President Evans (7/11) acknowledged risks from trade policy but emphasized that those must be considered in the context of the overall economic outlook, saying, “the strength of the economy is really pretty important at the moment.”
Policymakers continued to voice support for three or four hikes this year. Kaplan identified himself as supporting three hikes in 2018 but said an additional hike could be warranted (6/15). Bostic (6/26) linked his views on the pace of rate hikes this year to developments on trade: “I’m not off of three moves yet, but if [trade policy] progresses the way it has over the past couple of days I think the likelihood is I’ll be moving away from four as a real possibility.” He warned (6/28) that raising rates more than three times this year might bring the funds rate above its neutral level. President Rosengren continued to emphasize the need to normalize monetary policy to avoid needing to tighten more later, saying, “the policy path that will increase the probability of a longer recession-free period is the path where the economy does not run above capacity and thus, fall far below the sustainable unemployment rate” (6/28).
FOMC participants also discussed what to do once the fund’s rate nears its estimated neutral level. Outgoing New York Fed President Dudley said, “The federal funds rate will probably have to climb a little bit above neutral because the unemployment rate is already — from most people’s vantage points — below a sustainable level of unemployment consistent with stable inflation” (6/15). Commenting on what the FOMC should do once the funds rate reaches neutral, President Kaplan said, “that’s the kind of decision I don’t want to prejudge now. It’s the kind of decision I’ll look at a whole range of factors when we get to that point… the strength of the economy, what’s going on globally, what’s going on in the financial markets, what’s going on with the yield curve.” President Kashkari (6/28) reiterated that he would like to pause once the fund’s rate is at neutral, as did many of the more dovish policymakers.
The Fed’s balance sheet policy, as well as the recent updrift in the federal funds rate, also came up. Policymakers generally avoided attributing the updrift to a scarcity of reserves, with Kaplan (6/15) saying, “I don’t think I’m ready to say definitively whether it’s a scarcity of reserves or some other reason.” Dudley acknowledged that the equilibrium level of reserves might be higher than had been thought, but said, “the evidence at this point is not that strong.” He added that he didn’t “think it’s a huge problem or issue if it turns out that the banks…demand a trillion dollars of excess reserves versus $500 billion of excess reserves, and that would cause us to stop the balance-sheet normalization process somewhat earlier.” At his testimony, Powell (7/18) said, “So we’re learning, along with everybody else, as the balance sheet shrinks as to what the new normal will be. And I have to say, there’s a significant amount of uncertainty. We’ll learn a lot. You know, the markets are moving their estimates up, but I don’t think we’re going to know for some time exactly what that equilibrium size will be.” He referenced his previous estimate that it would take “three or four years” to reach a normalized size while emphasizing the uncertainty around such estimates.