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Federal Reserve Chair Jerome Powell is serious about crushing high inflation. Whether he actually succeeds—and how much collateral damage there is along the way—is an open question.
Powell reiterated his vows in his third speech of the Covid era during the Jackson Hole Economic Policy Symposium on Friday. It was his first in-person talk since 2019.
Two years ago at Jackson Hole, Powell’s speech made the case for letting prices rise above the Fed’s 2% inflation target. Last year he argued that inflation was transitory and would fall quickly.
How times have changed.
“The Federal Open Market Committee’s (FOMC) overarching focus right now is to bring inflation back down to our 2% goal,” Powell said. “The burdens of high inflation fall heaviest on those who are least able to bear them.”
With inflation well above the Fed’s target, economic growth slowing and unpredictable geopolitical events wreaking havoc on the global economy, Powell will have to maneuver nimbly if he wants to deliver a more sanguine message at next year’s symposium.
The Fed’s Crusade Against Inflation
Powell’s message was blunt, if not terribly surprising: Inflation is too high, and it’s hurting your pocketbook.
“Without price stability, the economy does not work for anyone,” Powell said. “In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.”
By any metric, U.S. prices are well above what any mainstream central banker would deem acceptable.
The most popular inflation measure, the consumer price index (CPI), was up 8.5% in July on an annual basis. Strip out volatile food and energy costs—so-called core CPI—and inflation was 5.9% over the same period.
What about the Fed’s preferred metric: core personal personal consumption expenditures (PCE)? That reading showed prices grew 4.6% over the past 12 months.
The good news is that the data show prices coming down from recent highs. Moreover, people don’t seem to believe that these sky-high price gains are here to stay. Inflation expectations are falling.
Powell made no news. He basically just clarified how the Fed’s thinking about inflation fighting, all of which is standard stuff.
The bigger news at 10 AM was UMich sentiment handily beating expectations (58.2 vs. 55.5) and long-term inflation expectations falling from 3 to 2.9%
— Joe Weisenthal (@TheStalwart) August 26, 2022
“Today, by many measures, longer-term inflation expectations appear to remain well anchored,” Powell said.
He also cautioned that these positive developments, while welcome, are hardly sufficient.
“But that is not grounds for complacency, with inflation having run well above our goal for some time,” Powell said.
In the Background, an Uneven Economy
The Fed has two jobs: keep prices stable and maximize employment. Powell’s speech reiterated that he’s willing to compromise the latter in order to achieve the former.
“Reducing inflation is likely to require a sustained period of below-trend growth,” Powell said. “Moreover, there will very likely be some softening of labor market conditions.”
That means the Fed may be willing to cause higher job losses if that results in people spending less so that inflation will come down.
Powell’s grim message comes after a bad start to the year. The economy declined by an annual rate of 0.6% in the second quarter of 2022, following a 1.6% drop in the first three months of the year.
The GDP declines should stop next quarter, according to the Atlanta Federal Reserve’s GDPNow tracker, which estimates the economy grew by an annual rate of 1.6% in the third quarter.
Nevertheless, there are dark clouds ahead. The message from relevant forward-looking indicators is worrisome, said Bill Adams, chief economist for Comerica Bank.
“These include dismal business and consumer surveys, the inverted yield curve, the drop in the Leading Economic Index, falling housing indicators and energy futures contracts which anticipate a surge in natural gas and electricity prices this winter,” said Adams.
With the unemployment rate sitting at a robust 3.5%, the Fed is willing to risk some job losses, and perhaps even a full-fledged recession, in order to get inflation back to its target level.
Wall Street Remains Hopeful
The initial reaction to Powell’s speech by markets was not terribly encouraging, with the S&P 500 falling by more than 1.5% immediately following his talk.
This comes after two months of steady stock market gains. Investors were buoyed by a pretty strong earnings season, plus highly optimistic expectations that the Fed was nearing the end of its rate hikes, and in fact would soon pivot to rate cuts sometime in 2023 as the economy faltered.
“I think the market is about 80% correct,” said Jeffrey Roach, Chief Economist for LPL Financial. “The Fed is most likely past the front-loading stage of the tightening cycle as inflation eases.”
Jerome Powell: Hawk or Dove?
Even Powell acknowledged that the Fed won’t be raising rates forever.
“At some point, as the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases,” Powell said.
But he also warned that “restoring price stability will likely require maintaining a restrictive policy stance for some time.”
That’s why Roach believes that while the Fed may slow down the pace of their rate hikes in the near future, that doesn’t mean they’ll suddenly turn dovish. They may pause, but that doesn’t mean they’ll actually cut rates.
The truth is that no one knows how this inflation story will end. Last year, all the smart money bet that inflation was transitory and the Fed had a handle on things. Powell’s speech today underscores how wrong that was.
Investors today, then, should get ready for a bumpy ride.
“Investors should continue to assess their personal risk tolerance, adjust their portfolio allocation as needed, and reconsider their investment objectives in light of elevated volatility,” said Robert Schein, chief investment officer of Blanke Schein Wealth Management.