Powell Was Blunt At Jackson Hole: He Will Crush Inflation And Any Part Of The Economy That Gets In His Way
A Long And Deep Recession Is All But Guaranteed
Jay Powell lost no time in getting to the point of his speech at the Jackson Hole Economic Symposium yesterday: The Fed will get inflation down to 2%, no “ifs”, “ands”, “buts”, or “maybes”.
Never mind that an actual inflation target is nowhere in the Fed’s actual mandate. Jay Powell wants inflation at 2% and he means to get it. Heaven help the economy that dares to get in his way (such as the US economy).
In a short, 8 minute address, Jay Powell laid out his inflation-fighting strategy for the foreseeable future: rate hikes, rate hikes, rate hikes, and, if those don’t work, more rate hikes.
Did I mention rate hikes?
Is this a sound strategy? Is this a wise strategy?
The answers are “not really” and “not likely.”
The Stock Markets Puked All Over His Speech
It took Wall Street less than 30 minutes after Powell finished speaking to surrender their stock market gains for the week. By 10:30 Eastern Time the Dow Jones Industrial Average was down 2.3% on the day. After a brief attempt at a rally just after lunchtime, the stock markets fell even further, with the DJIA down 4.2% on the day, the NASDAQ down 4.4%, and the S&P 500 down 4% on the day. The Russell 2000 small-cap index fared the best, “only” losing 2.9% on the day.
Clearly, the stock markets were not happy with Jay Powell.
On the other hand, forex markets were broadly approving of Powell’s remarks, with the dollar rising against the yen, the euro, and the yuan.
The bond markets mostly shrugged, with the 10 Year Treasury not moving much at all on the day.
Powell promised pain for businesses, and the stock markets took him at his word. The rest of Wall Street mostly yawned.
Powell Was Short On Words, Short On Facts, And Short On Logic
As has become the norm for Fed remarks of late, Powell wasted no time in jumbling facts and logic in an effort to sound both tough and competent. One suspects he was trying to sound like Paul Volcker circa 1979.
The Federal Open Market Committee's (FOMC) overarching focus right now is to bring inflation back down to our 2 percent goal. Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all. The burdens of high inflation fall heaviest on those who are least able to bear them.
While this was a strong opening, he proceeded to contradict himself almost immediately.
Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.
Inflation means the economy is broken, and so long as there is inflation labor markets will suffer….but to reduce inflation and restore price stability requires breaking the economy and making the labor markets suffer.
Yeah, that makes sense…not.
Powell went on to double down on the “economy is currently strong” (shades of the usual “we’re not in a recession” rhetoric that passes for policy commentary in Washington), including repeating the canard of a strong labor market.
The U.S. economy is clearly slowing from the historically high growth rates of 2021, which reflected the reopening of the economy following the pandemic recession. While the latest economic data have been mixed, in my view our economy continues to show strong underlying momentum. The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers. Inflation is running well above 2 percent, and high inflation has continued to spread through the economy. While the lower inflation readings for July are welcome, a single month's improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.
Again, if the labor market is strong with inflation, how can inflation be keeping the labor markets from being strong?
Of course, the labor markets are not strong, but are broken worse than the rest of the economy—so much so the BLS has to fudge the numbers to an embarrassing degree.
A labor market with declining labor force participation is hardly “strong”. A labor market with increasing numbers of marginally attached and discouraged workers is hardly “strong”. An labor market with a 36% increase in layoffs year on year is hardly “strong”.
All these are the factually established characteristics of the American economy and the American labor markets, and yet Jay Powell believes the labor markets are “strong.”
Reality is clearly not Jay Powell’s forte.
Powell Promised Harsh Medicine
With his misunderstanding and mis-statement of the current state of the economy well in hand, Powell made it quite clear how he sees the Fed’s mandate: drag supply and demand back into equilibrium kicking and screaming if need be.
It is also true, in my view, that the current high inflation in the United States is the product of strong demand and constrained supply, and that the Fed's tools work principally on aggregate demand. None of this diminishes the Federal Reserve's responsibility to carry out our assigned task of achieving price stability. There is clearly a job to do in moderating demand to better align with supply. We are committed to doing that job.
Imagine that! When demand outpaces supply prices go up! Thank you, Captain Obvious!
The last part of that sentence, about the Fed’s “tools” (read, “rate hikes”) working “principally on aggregate demand”, should send chills down every consumer’s spine. Powell sees inflation as too much demand and too little supply (notionally correct, by the way), and sees the solution to too much demand as a simple matter of eliminating the demand.
For the unpardonable sin of consumers wanting to buy things, Jay Powell intends to raise interest rates until consumers are no longer able to buy things. “Demand destruction” is what will save the economy…although it won’t do much for consumers in the short run.
Unfortunately for Jay Powell, the data thus far does not show his rate hikes yet having any meaningful impact on inflation.
After a 900% increase in the Federal Funds Rate since March, headline consumer price inflation per the CPI is exactly where it was in March: 8.5%. That 900% increase in the Federal Funds Rate produced a transitory 130% hike in the 10-Year Treasury Yield, which has since fallen back to an approximately 100% yield increase.
That last metric should give Jay Powell pause about future rate hikes by the Fed—for whatever reason, boosting the Federal Funds Rate is not producing a sustainable rise in Treasury yields. The correlation upon which his entire strategy depends is demonstrably not there. Arguably it should be there, but it isn’t, not at the strength of correlation he needs for the strategy to work.
As today’s market reactions illustrate, even Fed jawboning is not having much impact on treasury yields at the moment.
This Is Not The 1970s
Powell is basing his inflation fighting strategy on Paul Volcker’s economic shock therapy of the early 1980s. At first glance, that seems a reasonable thing to do, given Volcker’s apparent success at taming inflation.
However, there are glaring differences between the situation Volker faced and the present day.
First and foremost, by the time Volcker took the helm at the Fed, the Federal Funds Rate was already higher than the 10-Year Treasury Yield.
Additionally, inflation was never dramatically greater than the 10-Year Treasury yield, being just 2% greater than the 10-Year Treasury at inflation’s peak in 1980.
Finally, Volcker was quickly able to raise the Federal Funds rate above the rate of inflation, and after a few ups and downs in 1980, was able to keep the Federal Funds rate above inflation from October of 1980 onward (the reader will note that inflation was already on the decline at this point, which no doubt helped the situation immensely). The high Federal Funds rate pulled the 10-Year Treasury yield up was also above the pace of inflation, where it would largely remain until the 2020 mass monetary easing that saw all rates cut to near zero.
What Powell refuses to see is that, by slicing rates as low as he did in 2020, and by failing to act quickly to raise them when inflation started to rise, he took most of the economic punch out of the rate hikes that are the core of the Volcker approach to taming inflation. Where Volcker started out on top of inflation, Powell is still very much below inflation.
For rate hikes to work in the Volcker model, the Fed would have to raise the Federal Funds rate to at least 9% today, and hold it there while yields followed along.
This would, of course, decimate the funding of the federal government, as well as all state and local governments, as interest payments on new debt issuances would skyrocket, making funding untenable. Think China’s Evergrande only instead of a real estate developer substitute the government entity of your choice.
This is the problem with Powell persisting in channeling Paul Volcker on inflation. The Fed does not have the ammunition now that it had back then, and no real way to acquire that ammunition over the near term.
Powell can raise rates enough to cause households and businesses plenty of pain, but, barring a miracle, not enough to head off inflation—particularly food and energy price inflation, which are likely to continue an upward trajectory no matter what the Fed does.
Powell has promised the American economy a steady diet of pain and suffering, but without any tangible hope of inflation relief to compensate for it. That is not an inflation-fighting strategy that is going to end well for anyone.
I'm continuing to think of my earlier comment on the contradictory mandates of the Federal Reserve. If the Fed had a mascot, it should be the pushmepullya, the imaginary animal of Dr. Doolittle.
"Never mind that an actual inflation target is nowhere in the Fed’s actual mandate."
I'll respectfully disagree with you on this point. Half the Fed's mandate is "stable prices". Personally, I think that means they should target an inflation rate of 0%, at least over the long term, since even 2% inflation has a drastic effect on prices (and the value of the currency) over a span of decades, such as a typical person's working career of 40-odd years.