A few people have asked for my opinion on the speech Jerome Powell gave last week about the direction of Fed policy. So, here’s my take.
Powell’s Speech Points to Oncoming Economic Pain
First, unlike other speeches he’s given over the past few months, this one was a little less nuanced and a little more direct, addressing the problems we’re facing head-on, along with the solutions that the Fed is going to pursue. Not surprisingly, much of the short speech focused on getting inflation under control or what Powell referred to as “restoring price stability.”
In his comments, Powell was pretty direct in his belief that the efforts the Fed is prepared to undertake to control inflation will cause economic pain. In other words, we’re past the expectation that a “soft landing” is still possible.
Below are some of his specific comments, along with my interpretation. A link to the full speech is here:
Powell: The Federal Open Market Committee’s (FOMC) overarching focus right now is to bring inflation back down to our 2% goal.
My Thoughts: There have been many discussions recently about whether the Fed would be happy with inflation back down to 3-4% instead of the historical target of 2%. Powell seems to be very clear here that 2% is the goal, which likely means a more aggressive stance.
In fact, later in the speech, he specifically addresses this and says that now is not the time to step off the gas when we get close to 2%. There are too many risks if we don’t stay aggressive.
Powell: 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.
My Thoughts: This is the most direct admission we’ve gotten from the Fed that tackling inflation may not come quickly, will require some aggressive policy, and will likely lead us into higher unemployment and a clear recession, as well as potentially longer-term reduced GDP.
Powell: 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…Committee participants’ most recent individual projections from the June SEP showed the median federal funds rate running slightly below 4% through the end of 2023.
My Thoughts: This should reinforce expectations for another .75% rate hike in September unless we get a surprisingly good CPI number for the August time period. Even then, we’ll likely see at least a .50% hike. And it appears he’s preparing everyone for rates to potentially hit 4% before all of this is done.
Powell: 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…There is clearly a job to do in moderating demand to better align with supply.
My Thoughts: This little comment hasn’t been discussed much from what I’ve seen, but it deserves mention. Basically, Powell is saying that inflation is clearly being caused by both demand and supply issues (most agree) and that the Fed only has the ability to impact demand, not supply. This seems to me to be an admission that the Fed is concerned that they don’t have as much control over inflation in this situation as they’d like and are prepared to be extra aggressive if necessary.
Long story short, expect at least a couple more rate hikes this year, the core interest rate (the Federal Funds Rate) to potentially hit 4%, and don’t be surprised if we experience some significant economic pain for the foreseeable future.
Additionally, while it wasn’t explicitly addressed in the speech, I suspect we will see some additional tightening of the Fed balance sheet. While we’re currently seeing the Fed roll off mortgage-backed securities and bonds—meaning that they let these expire without buying more—I would be surprised if we start to see more aggressive selling of Fed assets over the next 6-12 months.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.