Jay Powell will make his debut as Chair before the congressional oversight committees next week. Here we identify important challenges he faces. First and foremost, his task is to establish himself before the oversight committees as a credible leader of the Fed and reassure the committees that he is in full command of the issues. He has to navigate the tension between a strengthening economy and policy guidance that has not changed even as forecasts have been progressively revised up. And, in any case, he must not get out in front of his fellow FOMC members. In all of his remarks, he must be seen as totally independent and immune to political influence. And, when the opportunity arises, he should emphasize to the congressional committees and the public that there will be no “Powell put.” In his tone and remarks, he will not want to materially change market expectations of the pace of rate hikes or have a material effect on market prices. Markets are still likely to see the testimony as to the hawkish side, but only because of the narrative on growth, the unemployment rate, and inflation.
Reassure the Oversight Committee about Your Leadership
It is often said that you only get one chance to make a first impression, and this is Powell’s maiden voyage as chair before the oversight committees and also the markets. The first priority is to impress the committees with his command of the issues and build their confidence in his leadership. This is a challenge because he succeeds two elite economists. Powell is not hard-wired in the same way to respond to questions on macroeconomic topics and monetary policy strategy. But he is nevertheless wired. He has been preparing during his five years as governor. He knows his stuff. But he needs to be clear, confident, calm, and
charming—and, of course, avoid glaring mistakes.
Navigate the Tension Between the Evolving Outlook and the Unchanged Policy Guidance
Powell takes the reins at a different point in the cycle than the FOMC has found itself for some time. For years, the narrative has been moderate growth around 2%; declining unemployment, first to the NAIRU and then modestly below it; and inflation projected to move to 2% over the next couple of years. That called for a gradual pace of hikes, which was what the FOMC anticipated for 2016, actually carried out in 2017, and now projects for 2018. But now we are at a different place, cyclically, than perhaps ever before: well-above
trend growth in 2017, with momentum into this year; an unemployment rate well below the NAIRU and expected to fall to as low as 3½%; more confidence that inflation is headed to 2%; and now a badly-timed and very large fiscal stimulus. In December, when it became clear that a tax bill would soon become law, they raised their growth forecast about ½ percentage point, and in January participants said they expected still-stronger growth. Since then, the passage of a two-year spending bill means that the fiscal stimulus will be much greater than the FOMC had anticipated at either of those meetings. We can confidently expect the third consecutive upgrade to the growth outlook in March.
That’s the outlook. The policy guidance is still based on the dots in December—three hikes this year. The only change admitted by the FOMC is a greater likelihood of three hikes. The tension is that the policy guidance, including in the January minutes, seems out of date and out of line with the evolving outlook. It is what it is. This is the policy message that Powell will have to stick to. He can’t get out in front of the FOMC, given that the median dot in March might, and likely will, still indicate only three hikes this year. He will repeat the policy language in the January minutes: The strengthening in the economy increases the likelihood of a gradual pace of rate hikes, literally taken as an increase in the likelihood of three hikes this year.
That’s not to say that markets will not price in a slightly higher probability of a March hike and more than three moves this year. But, if so, that is likely to be a result of Powell’s characterization of the strength of the economy, now boosted by the budget agreement as well as the tax cut.
The Stock Market Correction: A “Powell Put”?
Oversight committee members will give Powell every opportunity to be interpreted as the latest keeper of the “Fed put.” Powell will say that the recent decline in equity prices, now partially reversed, is viewed as a correction, not at all unusual after a long period of steady increases in equity prices. As such, the decline in equity prices, now quite modest, on the net, has little if any implication for the outlook and no significant implication for the course of monetary policy.
The more important story is that financial conditions remain easier than when the FOMC began to raise the fund’s rate, and that is also encouraging the FOMC to continue with its gradual pace of rate hikes. I asked about financial stability concerns, he can cite the conclusions of the staff update on risks to financial stability presented at the January meeting: The risks are assessed as “moderate.”
Clarifying the Implications of a Symmetric Inflation Objective
An important opportunity in this testimony is to begin the communication clarifying and expressing the Committee’s commitment to a “symmetric” inflation objective. But it is tricky to effectively say that the Committee will tolerate, if not welcome, an increase in inflation modestly and temporarily above the 2% medium-term objective. It’s more likely that this theme will emerge gradually through speeches and in the discussion in minutes before the Chair puts his mark on it.