Powell’s speech opening this year’s Jackson Hole conference highlighted the tension between significant uncertainty and downside risks, which have recently increased, and a resilient U.S. economy that is now in a “favorable place” despite having faced headwinds for some time from many of the sources of those risks (notably a worsening global economy, trade tensions, and the prospect of a hard Brexit). His comments on the outlook and monetary policy were consistent with what the minutes had suggested—albeit updated to reflect developments since the July meeting—so Powell’s speech didn’t meaningfully affect our views on the outlook for monetary policy. The July minutes suggested that the Committee was not at all set to cut again in September at that time. There was a range of views extending to both the hawkish and dovish side, with several opposing the July cut and a couple wanting 50 basis points. But the negative developments since
July, which Powell reviewed, suggests the FOMC will in fact cut rates, but only by another 25 basis points. We continue to expect only one more easing, which will happen at the September meeting.
Powell succinctly summarized developments in the “eventful” three weeks since the July meeting that have contributed to a “complex, turbulent picture”:
▪ announcement of new tariffs on imports from China
▪ further evidence of a global slowdown, notably in Germany and China
▪ current and prospective geopolitical events, including the growing possibility of a hard Brexit, rising tensions in Hong Kong, and the dissolution of the Italian government
▪ strong financial market reactions, including volatile equity markets and sharp downward moves in long term yields
He contrasted those developments with the still-benign incoming data on the U.S. economy since the July meeting:
▪ “Meanwhile, the U.S. economy has continued to perform well overall, driven by consumer spending.” ▪ Job growth is slower than it was last year but is still outpacing labor force growth. ▪ Inflation “seems to be” moving up closer to its objective.
Powell’s overview of U.S. economic developments was cursory, but still notable in several regards. First, it was unambiguously positive. There was no mention, for example, of signs of consumer sentiment dipping since the July meeting, though he did note the ongoing weakness in investment and manufacturing. And notably absent, of course, was any talk of perceptions of elevated recession risk, something that media and markets have been talking about a lot, particularly in the context of the recent decline in long-term rates and the corresponding inverted yield curve. While not dismissive of the risk of a sharper slowdown, the Fed doesn’t seem to see those risks as having increased in recent weeks as sharply as perhaps others are speculating.
The story with respect to inflation has shifted, something also apparent in the July minutes. Powell seemed pretty content with the inflation outlook given recent firmer readings. Indeed, he said the economy was “close” to meeting both parts of the FOMC’s dual mandate, though he acknowledged that there are still “concerns about a more prolonged shortfall.” Totally absent from this speech was any explicit mention of concerns about the current state of inflation expectations, even though he mentioned the critical importance of policymakers keeping inflation expectations anchored. It seems that too-low inflation (or inflation expectations) has faded somewhat as a rationale for easier policy for Powell, though not for all policymakers. At the same time, the risk of too-high inflation certainly remains of no concern. As Powell said, “in the unlikely event that signs of too-high inflation return, we have proven tools to address such a situation.”
His discussion and characterization of recent shifts in FOMC policy (not just the recent cut and downward revisions to the projected path of the fund’s rate before that) were very similar to what was presented in the press conference and minutes. He emphasized that, “Because the most important effects of monetary policy are felt with uncertain lags of a year or more, the Committee must attempt to look through what may be passing developments and focus on things that seem likely to affect the outlook over time or that pose a material risk of doing so.” He then turned specifically to developments with respect to trade policy, noting that “fitting trade policy uncertainty into this framework is a new challenge” and warning that monetary policy “cannot provide a settled rulebook for international trade.” However, policymakers can “try to look through what may be passing events, focus on how trade developments are affecting the outlook, and adjust policy to promote our objectives.” He explained that FOMC participants have “generally reacted to these developments [not only trade policy uncertainty, but also slowing global growth and muted inflation] and the risks they pose by shifting down their projections of the appropriate federal funds rate path.” And he sees that approach as having been successful in preserving a “largely favorable” outlook for inflation and employment. We see another cut, in September, as consistent with that approach given developments since July.
One notable omission from this speech was the term “mid-cycle adjustment,” which featured prominently in both the press conference and minutes for the July FOMC meeting. We suspect that Powell simply wanted to avoid elevating that term further in importance since it might be subject to varying interpretations. Indeed, even if he did not use that term, he noted the examples of the FOMC easing policy “during the long expansion of the 1990s.” We interpret the 1995 easing cycle as more of a mid-cycle adjustment and the 1998 easing cycle as more an example of risk management.
Powell presented a historical tour through “eras” of monetary policy and the questions raised and lessons learned. An important question is “whether long expansions supported by better monetary policy inevitably lead to destabilizing financial excesses,” which he called a “challenging and timely” one. His main conclusion that “we cannot prevent people from finding ways to take excessive financial risks. But we can work to make sure that they bear the costs of their decisions, and that the financial system as a whole continues to function effectively.” He then focused on the regulatory steps taken to contribute to financial stability, and concluded with this assessment: “We have not seen unsustainable borrowing, financial booms, or other excesses of the sort that occurred at times during the Great Moderation, and I continue to judge overall financial stability risks to be moderate. But we remain vigilant.” However, there appears to be no strategy about how to respond to financial stability risks outside the banking system that are more than moderate.
Like the market, we have a strong conviction that the FOMC will cut rates in September by 25 basis points. But Powell’s remarks today, like the July minutes, hint that there is a disconnect between market expectations for policy and policymakers’ own expectations. We see the FOMC easing in July and expected cut in September as a combination of “mid-cycle adjustment” and “risk management,” and hence not necessarily a prelude to further cuts after September.