Taper Time Is on the Way, Maybe. Powell Sets the Stage With Plenty of Caveats
By Lisa Beilfuss
Federal Reserve Chairman Jerome Powell signaled in his Jackson Hole speech Friday that the central bank may begin winding down its emergency bond-buying program this year.
Then again, it may not.
During his appearance at the annual conference hosted by the Federal Reserve Bank of Kansas City, Powell gave a speech that offered something for everyone: Inflation is hot but temporary; hiring is strong but could be better; the Delta variant may or may not be an economic problem.
He meanwhile avoided answering investors’ biggest questions: When will the Federal Open Market Committee start trimming its $120 billion in monthly Treasury and mortgage-backed securities purchases, and how long will the wind-down take?
“He tried to have his cake and eat it too,” says Joe Brusuelas, chief economist at RSM.
“And this time, he gets to.”
Investors seemed to agree, sending stocks to record highs after a speech that, on net, said little.
It is a case of no news is good news, in that every statement that could be interpreted as a sign that withdrawal of extraordinary monetary-policy accommodation is imminent was caveated by a reminder of why it isn’t.
At least for now.
Powell said that the Fed’s inflation objective has been met—an acknowledgment that came just after a report Friday showed the Fed’s favored inflation gauge rose a faster-than-expected 4.2% in July, or 3.62% after backing out food and energy prices. That latter rate is the highest since May 1991, and it is well above the Fed’s longstanding 2% inflation target.
“Businesses and consumers widely report upward pressure on prices and wages. Inflation at these levels is, of course, a cause for concern,” Powell said, throwing a bone to more hawkish Fed officials and concerned investors alike. Still, he went to great lengths in his speech to argue why inflation isn’t a problem, pushing back on a growing cadre of Fed officials expressing concern over rising prices and advocating for tapering to start this fall.
But pricing pressures aren’t broad, Powell argued, an observation that some investors say doesn’t comport with reality.
“I think he’s completely off base,” says Peter Boockvar, chief investment officer at Bleakley Advisory Group.
“Certainly every single good that is produced has major inflation pressures associated with it and services inflation is just heating up.”
Perhaps more importantly, Powell said long-term inflation expectations remain anchored—parlance intended to mean consumer expectations for higher prices more than a year out haven’t risen in a way that are pulling purchases forward and pushing prices even higher.
So long as consumers don’t see higher prices persisting, the logic goes, they won’t.
Boockvar notes that longer-term expectations tracked by the University of Michigan are at a 10-year high.
Alongside the inflation two-step came a subtle upgrade in his labor market outlook.
A reference to “clear progress” toward maximum employment is an upgrade from his earlier assessments, and investors can expect to see that reflected in the September FOMC statement, says Jefferies chief economist Aneta Markowska.
Yet here, too, Powell, gave an offset that nets to nothing in the scheme of reading policy tea leaves.
“Labor market conditions are improving but turbulent, and the pandemic continues to threaten not only health and life, but also economic activity,” he said, reminding investors that despite solid hiring in recent months, total employment remains six million below its February 2020 level.
Therein lies Powell’s ability to have it both ways a little longer.
“At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year,” Powell said.
“The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant.”
The fast-spreading Delta variant—which caused the Fed to scrap its own plans for an in-person Jackson Hole symposium—is the wildcard that may be the difference between a job market that normalizes in September and a job market that doesn’t.
Economists, employers, and policy makers have pinned an abundance of hope on September, predicting that the end of generous unemployment benefits and child care challenges that would presumably ease when kids return to in-person school would usher millions back into the labor market.
Because the labor shortage is the root of the everything-shortage, the idea is that more workers means more supply to satisfy roaring demand, which would in turn relieve price inflation.
It’s a big gamble.
It was during his Jackson Hole speech in 2020 that Powell unveiled the Fed’s new inflation framework, designed to let inflation exceed 2% after periods below that level—though by how much and for how long is unclear.
The point is to push unemployment lower, especially among groups that tend to experience higher rates of unemployment and lower wage gains such as Blacks and Hispanics.
The new framework was crafted before the pandemic, and investors and central bankers are watching a real-time stress-test of the new approach.
One key component of the new inflation framework is their insistence on actual data rather than just forecast data, says Mondher Bettaieb-Loriot, head of corporate bonds at Vontobel Asset Management.
Inflation repeatedly undershot officials’ inflation forecasts for the decade leading up to the pandemic, which explains the Fed’s caution on making moves based on inflation data, Bettaieb-Loriot says.
Focusing on data over forecasts suggests officials have nowhere to be but behind the inflation curve.
Powell gave no indication Friday that the Fed is questioning its new framework, instead signaling that it hasn’t been fulfilled.
To that point, Powell stressed Friday that tapering “will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test.”
Add it all up and the message is a dovish one, for now, that may portend a hawkish surprise later.
Economists at Goldman Sachs say they continue to expect the Fed to formally announce the start of tapering in November, assigning 45% odds to that outcome, 35% odds of a December announcement and 20% odds of a 2022 announcement.
Once tapering starts, Goldman sees reductions of $15 billion per FOMC meeting which would take eight months to complete.
The bottom line?
The Fed likes the box it has put itself in, where it is in some ways shielded from reality.
The unemployment objective is an elusive one given that current monetary policy may be undermining efforts to reduce joblessness and increase purchasing power.
For now, that means investors can count on the stock market party persisting.
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