The day's most anticipated moment arrived when moments ago Fed chair Jerome Powell released his speech titled "Changing Market Structure and Implications for Monetary Policy" which appears to have no surprises, and underscores the Fed's gradualist policies and highlights the same key themes the Fed touched in its latest minutes, to wit it expects the "strong economy to continue" and since there "does not seem to be elevated risk of overheating", the "gradual process of normalization [i.e. rate hikes] remains appropriate."
"The economy is strong. Inflation is near our 2 percent objective, and most people who want a job are finding one," Powell said. "My colleagues and I are carefully monitoring incoming data, and we are setting policy to do what monetary policy can do to support continued growth, a strong labor market, and inflation near 2 percent."
"There is good reason to expect that this strong performance will continue," Powell said adding "I believe that this gradual process of normalization remains appropriate."
Powell also says that there are no clear signs of inflation accelerating above 2% (even those core CPI is now 2.4%), and curiously, Powell even explicitly cited Draghi saying:
As Brainard made clear, this is not a universal truth, and recent research highlights two particularly important cases in which doing too little comes with higher costs than doing too much. The first case is when attempting to avoid severely adverse events such as a financial crisis or an extended period with interest rates at the effective lower bound.
In such situations, the famous words “We will do whatever it takes” will likely be more effective than “We will take cautious steps toward doing whatever it takes.” The second case is when inflation expectations threaten to become unanchored. If expectations were to begin to drift, the reality or expectation of a weak initial response could exacerbate the problem.
I am confident that the FOMC would resolutely “do whatever it takes” should inflation expectations drift materially up or down or should crisis again threaten."
For now, however, that does not appear to be a threat.
Powell discussed the challenges of monetary policy at a time when economic benchmarks - such as estimates of full employment or the neutral policy rate - are uncertain (more on that below in his discussion of NAIRU and r-star). The two risks faced by the Federal Open Market Committee are moving too fast and shortening the expansion, or moving too slowly and allowing for overheating and financial excesses.
Another curious omission: no mention of Fed "independence" in light of Trump's recent attacks on the Fed, nor a reference to risks stemming from "trade" - as the FOMC Minutes did - or any mention of the word "tariffs", however Powell did note that "there are risk factors abroad and at home that, in time, could demand a different policy response, but today I will step back from these."
In a tangent, early on in the speech Powell strongly endorses the Alan Greenspan-style approach to setting monetary policy based on risk management. He cites Greenspan's late-1990s success in keeping rates low because of a productivity boom he detected, suggesting Powell would be on the lookout for productivity gains from current administration policies.
Of course, everyone knows how this late 1990s Greenspan "success" ended - with the dot com bubble, which needed progressively bigger Fed bubble to be reflated to keep the economy going. But we digress...
Meanwhile, one of the reasons why the speech is being perceived as dovish by the market is the following segment focusing on the Fed's gradualism:
"While inflation has recently moved up near 2%, we have seen no clear sign of an acceleration above 2%, and there does not seem to be an elevated risk of overheating.''
“This is good news, and we believe that this good news results in part from the ongoing normalization process, which has moved the stance of policy gradually.”
"As the most recent FOMC statement indicates, if the strong growth in income and jobs continues, further gradual increases in the target range for the federal funds rate will likely be appropriate.”
To commentators this is a sign that there is no reason to push up rates rapidly with inflation as a target.
Powell also touched on NAIRU and the collapse in the Phillips curve:
I will focus today on one of the many facets of uncertainty discussed at the 2003 symposium--uncertainty around the location of important macroeconomic variables such as the natural rate of unemployment. A good place to start is with two opposing questions that regularly arise in discussions of monetary policy both inside and outside the Fed:
- With the unemployment rate well below estimates of its longer-term normal level, why isn’t the FOMC tightening monetary policy more sharply to head off overheating and inflation?
- With no clear sign of an inflation problem, why is the FOMC tightening policy at all, at the risk of choking off job growth and continued expansion?
These questions strike me as representing the two errors that the Committee is always seeking to avoid as expansions continue--moving too fast and needlessly shortening the expansion, versus moving too slowly and risking a destabilizing overheating.
Speaking of NAIRU, the Fed has it as 5%, about 1% above the current unemployment rate.
Here is Powell's take of r-star, or the neutral real rate of interest, which the FOMC currently see as just below 1%.
And here is Powel's take on being incorrect in the Fed's calculations of r-star and NAIRU:
"The risks from misperceiving the stars also now play a prominent role in the FOMC's deliberations. A paper by Federal Reserve Board staff is a recent example of a range of research that helps FOMC participants visualize and manage these risks. The research reports simulations of the economic outcomes that might result under various policy rules and policymaker misperceptions about the economy. One general finding is that no single, simple approach to monetary policy is likely to be appropriate across a broad range of plausible scenarios."
Some other speech highlights:
- “I see the current path of gradually raising interest rates as the FOMC’s approach to taking seriously both of these risks,” he says in text of speech at Fed’s annual policy symposium in Jackson Hole, Wyoming
- “With solid household and business confidence, healthy levels of job creation, rising incomes, and fiscal stimulus arriving, there is good reason to expect that this strong performance will continue”
- “While inflation has recently moved up near 2 percent, we have seen no clear sign of an acceleration above 2 percent, and there does not seem to be an elevated risk of overheating”
- “This is good news, and we believe that this good news results in part from the ongoing normalization process, which has moved the stance of policy gradually closer to the FOMC’s rough assessment of neutral as the expansion has continued”
- “As the most recent FOMC statement indicates, if the strong growth in income and jobs continues, further gradual increases in the target range for the federal funds rate will likely be appropriate”
And while it may disappoint some, there was no mention of any long-term forecasts, or what the Fed intends to do in 2019.
In kneejerk response to his speech, and specifically the statement that there was no risk of overheating, no clear sign of inflation accelerating above 2% and that the FOMC will do what it takes to keep inflation expectations from drifting, the dollar slumped...
... and stocks spiked.
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The full speech, which was devoid of any material surprises, is below (link)