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"New Fed News Service": Powell's "turn" caused market confusion
2023-12-21
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On Wednesday (December 20), "New Fed News Agency" and Wall Street Journal reporter Nick Timiraos wrote that Federal Reserve Chairman Jerome Powell was asked at a recent gathering what he did for fun. He paused, then smiled.
“To me, a really big party — and this is fun — is a really good inflation report,” he said to laughter at Spelman College in Atlanta earlier this month.
Powell finally got what he wanted: a significant decline in inflation. But that creates a familiar headache, making it harder to convince investors that a rate cut is imminent as Fed officials want to keep their options open.
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After last week's policy meeting, Fed officials forecast at least three interest rate cuts next year. They have since been baffled by investors' expectations for faster and deeper rate cuts. The result: Confusion over when and how quickly the Fed will cut interest rates as it tries to lower inflation without triggering a painful recession.
Richmond Fed President Barkin said in an interview on Tuesday: "If you convince yourself that inflation has reached the level you want, I am not opposed to lowering interest rates." "But I am still looking for inflation to stabilize at the Fed 2% goal rather than belief above”.
Officials last week did not rule out raising interest rates. But Powell triggered a market rally by proactively asking some officials to describe their own vision for rate cuts, even if that wasn't the focus.
He also said lower inflation this year means officials can focus on avoiding keeping interest rates too high for too long. The Federal Reserve recently raised its benchmark federal funds rate to a range of 5.25% to 5.5% in July, a 22-year high.
Powell has spent the past year preparing for a protracted, hand-to-hand battle with inflation. Since July 2022, he has pointed out at every post-meeting press conference that lowering inflation may require weak growth and hiring.
Powell omitted those last week, stressing that the Fed was surprised by the recent decline in inflation without any increase in unemployment. "Inflation continues to decline," Powell said. "We thought things would get more difficult from now on, but so far, they haven't."
Julia Coronado, founder of economic consulting firm MacroPolicy Perspectives, said that given recent inflation performance and the apparent shift in Powell's vision, "the Fed should not be surprised by the volatility in the market."
Subsequently, several Fed chairs poured cold water on speculation of a rate cut in March. Chicago Fed President Goolsby said the market's reaction to Powell was puzzling. "We will not speculate speculatively on specific policies regarding the future," he said on Monday.
Tug-of-war with the market
Over the past year and a half, the Federal Reserve and the market have been engaged in a tug-of-war, with the market often expecting inflation to fall faster than the Fed and to cut interest rates more deeply.
But the current situation feels different, as inflation has been at or near the Fed's target in five of the past six months. "The difference is in the data," said Krishna Guha, vice chairman of Evercore ISI. "Deflation is happening earlier and faster than the Fed cautiously expected."
Last week, Fed officials expected core inflation, which excludes volatile food and energy prices, to end the year at 3.2%.
Data received during last week's Fed meeting showed that inflation was very tame in November, as measured by the Commerce Department's preferred inflation measure, which is due to be released on Friday. Powell said that based on private sector forecasts, the six-month annualized core inflation rate could reach or fall below 2%, and the 12-month inflation rate could fall to 3.1%.
Powell said last week that some officials had lowered their inflation forecasts following the release of new data on the final morning of the Fed meeting. (Officials did not revise their rate forecasts).
While it's natural for markets and the Fed to disagree on their policy vision, recent comments from officials suggest some are uneasy about the likelihood of a rate cut in March.
The question is whether Fed officials think the market is "completely wrong" or think such an outcome is reasonable but "don't want to be stuck with two meetings three months from now," Guha said.
Fed officials' half-hearted resistance in recent days suggests the latter.
Echoing "Powell's remarks"
Other officials echoed Powell's sentiments, noting that lower inflation has made them more eager to limit the risk of a recession that may not be necessary to remove price pressures.
Some say even if the economy does not worsen, interest rates should be lowered appropriately next year to prevent inflation-adjusted or "real" rates from rising as inflation falls.
San Francisco Fed President Daley said in an interview on Monday that interest rates would still likely be quite constrained "even if we adjust policy with three rate cuts next year."
Federal Reserve officials and policymakers in the Biden administration are relieved that the economy continues to grow strongly and inflation is falling.
Earlier this month, U.S. Treasury Secretary Janet Yellen said economists who said last year that lowering inflation would require very high unemployment were now "going back on their word."
"A year ago, many economists were saying a recession was inevitable," Yellen said in an interview last week. "But I never actually felt that there was a solid intellectual basis for making such a prediction."
If markets are giving Fed officials heartache, it's partly because of their own PO's "dot plot," in which a dot represents each official's forecast for interest rates. Powell's Fed relies on this guidance to transmit its interest rate policy to financial markets. This can be trickier when there is more uncertainty.
Last week, two officials predicted no rate cuts next year, while one forecast the equivalent of six quarter-point cuts. "That's a pretty wide range" from which signals can be picked up, Barkin said.
The end of "higher and longer"
Dot plots sometimes frustrate policymakers. Part of the reason is that it's built from the bottom up rather than from the top down. Officials submit their forecasts a week before the meeting and don't see submissions from 18 colleagues until the night before the meeting.
The market attaches great importance to the median, even though the median is not a product of formal discussion. "Some people will talk about their views and some won't, but there won't be ... group conversations or strategizing," Barkin said.
Last week, officials' median forecast for three quarters of rate cuts in 2024 was the friendlier of the two options analysts considered most likely. Some expect central bankers to expect only two rate cuts next year, in part to keep markets from anticipating more.
Jeffrey Cleveland, chief economist at Payden & Rygel, said that before the Fed meeting, my bias is that they want to be really sure that the inflation rate will return to 2%, not 3%, not 3.5%. He doesn't expect officials to plan for that many or any cuts because they'll be willing to wait.
As a result, Powell began to distance himself from the Fed's "holding higher rates for longer," a strategy officials proposed earlier this year when inflation looked more stubborn and they were unsure whether to continue raising rates. Even if officials abandon that approach, "the bond market has gotten too far ahead of its time," Cleveland said.
The above information is provided by special analysts and is for reference only. CM Trade does not guarantee the accuracy, timeliness and completeness of the information content, so you should not place too much reliance on the information provided. CM Trade is not a company that provides financial advice, and only provides services of the nature of execution of orders. Readers are advised to seek relevant investment advice on their own. Please see our full disclaimer.
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