November 25, 2022 | 11:52
Powell Walks a Tightrope
Fed Chair Powell will speak on the economy, inflation and labour markets on Wednesday, followed by an interview and audience questions. This is an opportunity to shape market expectations ahead of the December 13-14 policy meeting. Markets (and we) expect a 50 bp rate increase after an unprecedented four straight 75 bp moves. Powell’s delicate task will be to confirm expectations of a slower cadence while emphasizing that such is still data-dependent and that rates are likely to keep rising for a while. In a nutshell, don't equate slower with lower.
The tapering case received support from a “substantial majority” of FOMC members at the last meeting, and rests on two pillars. First, with the current policy rate target range of 3.75%-to-4.00% well above the presumed neutral range of 2%-to-3%, policy is now materially restrictive. So, the Fed can pivot from the “forthrightly” stage of what was needed to catch up to runaway inflation to a nimbler approach that acknowledges the lagged effects of policy and gives some consideration to avoiding a deep downturn.
Second, the inflation news has been less dire of late. There is clearer evidence of peaking now that oil prices are below $80, goods prices are unwinding their pandemic bounce, and retail discounting is on tap this holiday season. Retailers need to clean out extra items that were previously in high demand during the pandemic and housing boom, such as computers, toys, and appliances, especially after they over-ordered to get ahead of feared supply bottlenecks that have since partly subsided.
The case for higher for longer also rests on solid ground. In fact, underscoring Powell’s post-presser message, the Minutes of the last meeting warned that peak rates could be “somewhat higher than... previously expected”. This sentiment reflects several factors. First, to the surprise of most (including the Fed), the economy appears to be catching a fourth wind. We’ll know more after next week’s personal spending and payroll releases, but it’s entirely possible that both spending and real GDP will have a 3-handle in the current quarter, marking the fastest pace this year. That decidedly goes against the grain of the Fed’s aim to achieve “a period of below-trend real GDP growth” to bring “aggregate supply and aggregate demand into better balance”. Beside resilient consumers, business spending is also turning up according to the latest data on capital goods orders and shipments. Meanwhile, though the housing market should remain depressed into next year, the sharpest declines in activity are likely behind us, implying less drag on growth. Surprising increases in new home sales and mortgage applications fit this mold, though both series are volatile.
Second, financial conditions have eased amid rallying equity and bond markets. That’s the last thing the Fed needs. Sure, markets could reverse lower, as they did late summer and early fall, but further gains will only compromise the Fed's ability to restore price stability and avoid a deep recession.
Third, the job market remains tight with little indication that wage pressures are subsiding. A big jump in UI claims that appeared to go beyond the high-profile layoffs in the tech space could mark the start of looser labour market conditions. But the fact is that employment remains too strong for an inflation-fighting Fed. Next Friday’s jobs report should confirm that, while hiring has slowed, it's still running faster than normal, and risks pushing the jobless rate down rather than up. The Fed knows that neither wages nor inflation will cool if that happens.
The upshot is that the Chair will need to walk a fine line on Wednesday. Whether he tones down the hawkish rhetoric of his post-meeting presser, or provides a more balanced view of the policy situation as reflected in the statement and Minutes, is anyone’s guess. But he will surely aim to avoid extending a market rally that can only make his job harder.