Punting On A Rate Hike, Powell Seems Confused
Punting On A Rate Hike, Powell Seems Confused
It's Not Enough To Just Look At The Data. Powell Must Also Understand It.
As Wall Street expected, the Federal Reserve opted not to increase the federal funds rate another 25bps during this latest meeting of the FOMC.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5 to 5-1/4 percent. Holding the target range steady at this meeting allows the Committee to assess additional information and its implications for monetary policy.
As I had observed before the FOMC press release yesterday, this was exactly what Wall Street had been expecting from the Fed.
Given the fairly positive inflation report Tuesday, Wall Street’s anticipation of the Fed holding the line were perfectly reasonable and in line with the data for once.
However, Wall Street’s reaction to the Fed’s announcement that rates would not be raised was hardly one of enthusiasm. Rather, Wall Street took little comfort in either the announcement or what Powell indicated lay ahead in the Fed’s fight against inflation.
The muddled response was fitting, however, as during the press conference it became apparent Powell either is not looking at the data or is completely confused by it.
Despite having had their prediction of no rate hike confirmed, Wall Street’s initial reaction to the FOMC announcement was negative, with the major stock indices heading south on the news.
During the press conference that followed, however, the market managed to regain most of the ground it lost.
Bond markets largely followed suit, with the short term Treasury yields mostly moving sideways on the day.
Only the 2 Year Treasury showed any definitive yield increase on the day.
Surprisingly, despite the FOMC decision aligning with Wall Street expectations, Wall Street sentiment started out negative and then shifted to a positive note by the end of Powell’s press conference. This may have had something to do with the FOMC’s position that the federal funds rate still needs to be raised this year.
Although the FOMC decided not to raise the federal funds rate at this meeting, the consensus among the committee members is that the federal funds rate needs to be at a median level of 5.6% for 2023. Simple math says that means at least another 50bps of rate increase are on deck sometime this year—probably as soon as next month’s meeting.
Jay Powell reiterated this in his opening statement at his press conference following the conclusion of the FOMC meeting.
As I noted earlier, nearly all committee participants expect that it will be appropriate to raise interest rates somewhat further by the year. But at this meeting, considering how far and how fast we’ve moved, we judged it prudent to hold the target range steady to allow the committee to assess additional information and its implications for monetary policy.
However, at the very first question asked, Powell sounded more on the “dovish” than “hawkish” side of the rate hike question, leaving open the possibility that a rate hike might not happen next meeting.
So at the outset, going back 15 months, the key issue was how fast to move rates up and we moved very quickly by historical standards. Then last December, after four consecutive 75-basis point hikes, we moderated to a pace of 50—of a 50-basis point hike and then this year to three 25-basis point hikes at sequential meetings.
So it seemed to us to make obvious sense to moderate our rate hikes as we got closer to our destination. So the decision to consider not hiking at every meeting and, ultimately, to hold rates steady at this meeting I would just say it’s a continuation of that process.
On the question of how inflation would come down—in particular, where the disinflation would most likely occur—Powell’s assessment seemed at odds with the data he prizes so highly.
So your question is where is the—where is the disinflation going to come from and, you know, I don’t think the story has really changed. We—the committee has consistently said and believed that the process of getting inflation down is going to be a gradual one. It’s going to take some time, and I think you go back to the three-part framework for core PCE inflation, which is, we think, as good an indicator as you can have for where inflation is going forward. You start with goods. With goods we need to see continued healing in supply conditions—supply side conditions. They’ve definitely improved a substantial amount but if you talk to people in business they will say it’s not back to where it was.
So that’s one thing and that should enable goods prices to continue—inflation to continue to come down over time.
Powell ignored a few realities contained within the data, starting with the reality that core inflation per the PCE Price Index has so far remained in a band at 5% ±0.5%, even though core inflation per the CPI finally broke through the bottom of its band of 6% ±0.5%.
But even more crucially Powell ignored the data published just yesterday morning regarding the Producer Price Index—widely presumed to be a leading indicator on consumer price inflation.
One the one hand, year on year producer price inflation has been decreasing since March of last year.
So sustained has been the decrease that, month on month, producer prices have been showing deflation since that same time.
However, the internals of that decline are somewhat muddled.
While producer prices for goods have been declining since last June, producer prices for services have been steadily increasing, with PPI for Final Demand aggregating the two trends into a plateau.
Even the data on the PPI for goods presents a somewhat contradictory picture. While PPI for Final Demand, Goods, and Services all show disinflationary trends, that picture changes when the more volatile food and energy components are excluded.
While energy prices show the same disinflationary shift starting in July of last year, food prices didn’t make that shift until much later, around November. Most crucially, however, is that PPI for Final Demand Less Food And Energy has not made a disinflationary shift at all. Virtually all of the month on month price disinflation comes from declines in either food or energy.
This can also be seen in the base indices themselves, with PPI for Final Demand For Goods showing a decrease from last June, while PPI for Final Demand for Goods less Food and Energy shows only some moderation of price increase.
Outside of food and energy, the Producer Price Index for Final Demand for either Goods or Services is failing to show any price decrease.
The expectation that goods inflation will ameliorate over time cannot be supported by the PPI data. We should also note that an expectation that increasing the federal funds rate will impact goods inflation is also not supported by the PPI data, as it shows no impact in “core” PPI for goods or for services across the entire time frame of the Fed’s rate hikes to date.
Ironically, Powell missed both realities in his answer justifying the FOMC decision to skip a rate hike this meeting, even as he bound the decision making process once again to the data.
In terms of speed, it’s what I said at the beginning, which is speed was very important last year. As we get closer and closer to the destination—and according to the SEP, we’re not so far away from the destination in most people’s accounting—it’s reasonable, it’s common sense to go a little slower, just as it was reasonable to go from 75 basis points to 50 to 25 at every meeting. And so the committee thought overall that it was appropriate to moderate the pace, if only slightly. And there are benefits to that.
So that gives us more information to make decisions. We try to make better decisions. I think it allows the economy a little more time to adapt as we—as we make our decisions going forward. And we’ll get to see, you know, we haven’t really—we don’t know the full extent of the consequences of the banking turmoil that we’ve seen. It would be early to see those, but we don’t know what the extent is. We’ll have some more time to see that unfold. I mean, it’s just the idea that we’re trying to get this right, and that this is—if you think of the two things as separate variables, and I think that the skip—I shouldn’t call it a skip—the decision makes sense.
What Powell ignored completely is that the PPI picture for Intermediate Demand—for goods that are in turned used in the manufacture of other goods—is also somewhat muddled.
Much like the energy-driven decreases in the PPI for Final Demand for Goods, the PPI for Intermediate Demand for Unprocessed Goods shows significant decline since June of last year. PPI for Intermediate Demand for Processed Goods shows a considerably more muted decrease.
It is surely no coincidence that unprocessed goods are largely energy-related commodities such as crude oil and natural gas. Oil has been declining since last June, with natural gas declining since last August.
Energy price decreases may serve to explain why PPI for Manufacturing and Transportation have decreased since last June, while PPI for Wholesale Trade, Warehouse Industries, and Retail Trade have either held steady or have increased.
The energy-driven reality of producer prices (and, by extension, consumer prices) was entirely ignored by Powell in his befuddled answer when asked to defend the Fed’s analysis of the data on both the economy and inflation.
You know, I mean, on the first part, I just think we’re following the data and also the outlook. The economy is—the labor market, I think, has surprised many if not all analysts over the last couple of years with its extraordinary resilience, really. And it’s just remarkable. And that’s really, if you think about it, that’s what’s driving. It’s job creation. It’s wages moving up. It’s supporting spending, which in turn is supporting hiring. And it’s really the engine, it seems, that is driving the economy. So it’s really the data.
In terms of—you know, we always write down at these meetings what we think the appropriate terminal rate will be at the end of this year. That’s how we do it. It’s based on our own individual assessments of what the most likely path of the economy is. It can be—it can actually, in reality, wind up being lower or higher, and there’s really no way to know. But it is—it’s what people think as of today. And as the data comes in, it can move around during the intervening period. It could wind up back in the same place. But it really will be data driven. And I can’t—I can’t tell you that I ever have a lot of confidence that we can see where the federal-funds rate will be that far in advance.
The Fed is committed to its decision processes being “data driven”, but Powell really can’t say how the data is driving the decision processes or over what horizon the decision processes are being driven.
Small wonder the markets took comfort in Powell’s answers over what the FOMC assessed will be the case for the federal funds rate going forward: if Powell’s view is any guide, the FOMC is content to be buffetted by the data as it gets released, and thus is most heavily influenced by the last piece of data it gets before making a decision. That makes any future rate increase nothing if not problematic.
Lost to both Wall Street and Jay Powell is the curious dichotomy of the PPI data: Energy prices are showing a strong deflationary trend—and that is what has been bringing down headline consumer price inflation—even as goods and services exclusive of energy are showing continued price inflation. Manufacturing prices are trending down, but wholesale, warehousing, and retail prices are still trending up.
In other words, the PPI data is showing sustained trends of both deflation and inflation simultaneously. This in turn suggests that the headline consumer price inflation will continue to decrease more rapidly than the core metrics—something the FOMC anticipates will be the case but makes no attempt to explain. Moreover, should shelter costs reverse their trend and begin trending up again, core inflation is almost sure to rise, as it is getting no downward pressure from either goods or services, based on the PPI data.
Neither inflationary nor deflationary trends are benign trends in any economy. Inflation means consumers are paying more and buying less, while deflation invariably means there is simply less buying—and less producing—period. To have both happening simulatenously indicates an economy that is dysfunctional and unbalanced, perhaps even dangerously so.
Yet the Fed remains studiously oblivious to this, preferring instead to focus on a few cherry-picked data points such as unemployment, deriving a sense of the US economy that is at best of problematic accuracy, and at worst completely misinformed. Judging by the questions Powell fielded yesterday about the FOMC meeting, the corporate financial media is equally oblivious to the PPI data and the growing dysfunctions it presents.
For all of Jay Powell’s lip service to the ideal of a “data driven” Federal Reserve, Powell is either not really looking at the data or not really understanding it. Powell is certainly ignoring several macroeconomic trends lying beneath the headline numbers—a mistake he shares with the corporate financial media, which fails time and again to look past the headline numbers to consider the longer-term ramifications of any data set.
With goods prices increasing and energy prices decreasing, the disparity between headline and core inflation is only going to grow, as will the inversion that puts core inflation higher than the headline number. No disequilibrium such as that can ever be sustainable in the long run, which means there is an economic shift up ahead where these trends will self-correct back towards an equilibrium position.
What that shift will be specifically, or when it will be, are two questions that, for the moment, remain unanswered. Yet the lack of answers for those questions should not blind us to the answers on the state of the economy that we do have—that the economy is unbalanced and getting more so.
If the Fed was truly data driven, if Jay Powell was not only looking at all of the data, but trying to understand it as well, we would be seeing more and more coherent discussion of the data after each FOMC meeting and rate increase decision. That we are not getting that discussion means Powell is either not looking at the data or is failing to understand it.
Which mistake Powell is making ultimately is a distinction without much difference, as both lead to the same misapprehension of the state of the economy overall.