Heading into the Kansas City Federal Reserve’s annual symposium in Jackson Hole, Jerome Powell, chairman of the Federal Reserve, sought to provide a clearer outlook for monetary policy in the United States. The Fed had just cut the federal funds rate for the first time since 2008.
The cut was made despite unemployment in the U.S. being near 50-year lows and consumer confidence remaining resilient. While growth over the past four quarters has averaged 2.3%, the Fed sees many political and structural headwinds affecting the outlook for employment and inflation in the U.S.
Three Questions about Monetary Policy
The theme of Chairman Powell’s speech was three questions about monetary policy that have arisen in three time periods since WWII. His first question was, can the Fed keep inflation low in the face of short-term employment and wage gains while risking higher inflation later? This question arose out of the “Great Inflation” time period from the late 40’s to early 80’s when the economy sporadically shifted from deep recessions to times of six percent growth. The Fed would bend to short-term pressure to boost employment numbers, which led to high inflation during expansions in this time period.
Powell’s second question, do longer expansions lead to the bubbling of assets and the destabilization of financial assets? This was seen multiple times during the “Great Moderation” period which took place from the early 80’s to 2008. Long expansions preceded the tech bubble burst on Wall Street in 2000, and not long after, the housing market collapse in 2008 which led to the Great Recession. The longer expansions run, the less investors tend to remember the effects of the last, leading to more risk and the inflation of asset prices.
The final question Powell asked the world’s best and brightest financiers was how the Fed and the rest of the world’s central banks can best reach full employment and price stability in the current low neutral rate environment? This question arose from the decade following the Great Recession and the low interest rate world that persisted, despite the U.S. boasting the longest expansion on record.
Did Powell’s Answers Indicate the Fed’s Next Move?
The Federal Reserve has answered the first two questions to the best of their ability. While no one can predict the next bubble burst with complete certainty, the Fed and other regulators across the world have helped to mitigate the size and scope of future bubbles. Over the past 25 years high inflation has not been an issue; if anything, too low inflation has been on the Fed’s mind over the past decade.
That leads us to the question burning in central banker’s minds across the world, how can they best promote full employment and stable prices in a world of interest rates well below historical expansionary norms?
Chairman Powell reiterated that Fed is data dependent and uses a wide range of data, not only from the U.S., but from the rest of the world to influence rate setting decisions. Although data from the U.S. is solid, with solid job numbers and inflation that seem to be moving closer to the 2 percent goal, there have been significant global developments that have required central bankers to adjust their policy rate projections downward.
There can be a significant lag in the effectiveness of monetary policy, so central bankers must forecast how current uncertainties will affect the economy in the future and act with precaution. Powell emphasized risk management in current decision making, as the Fed does not have leeway to lower interest rates significantly before reaching zero.
Powell Discusses 3 Major Concerns with the US Economy
Jerome Powell also focused on three major issues concerning the U.S. economy that have been dampening growth prospects in the U.S. First, inflation has been persistently below the 2 percent target for much of the past year. Second, trade disputes around the world, most notably between the United States and China, have created much uncertainty in world markets. This uncertainty has stifled investment and manufacturing spending both domestically and abroad, which leads us to the third issue of deteriorating global growth. China is seeing its economy slow to its most sluggish growth rate in almost 30 years, the euro-zone continues to slow bringing the robust German economy to a standstill, and Britain has been flirting with negative growth rates as the vote to leave the E.U. has escalated trade tensions between many of its closest neighbors. These issues were used as rationale for the recent cut to the target federal funds rate, and they seem to have only gotten worse since.
Further tariffs in the trade dispute with China, the growing likelihood of a hard Brexit, and growing political unrest in Hong Kong and Italy are a few of the major developments since August 1st. These factors have intensified uncertainty and rattled equity markets to the core. In addition, stocks in the U.S. have erased almost all the summer gains that brought them to record highs, and it seems that any moment could deliver a tweet could send them plummeting.
Did Powell signal a rate cut?
Powell stopped short of giving definitive monetary policy direction for the next few months. He indicated that much of the need for monetary policy stems from trade policy uncertainty between the U.S. and China. Fitting the current trade situation into their framework has been a huge issue and has tested the Fed’s ability to stay independent from political pressures, while focusing on the statutory dual mandate of price stability and full employment. Monetary policy, Powell argues, “is a powerful tool that works to support consumer spending, business investment, and public confidence. It cannot provide a settled rulebook for international trade.”
In the absence of a clear monetary policy schedule, Chairman Powell did repeat his favorite phrase as of late, “we will act as appropriate to sustain the expansion”. Many see this as an indication of future rate cuts since it has been used in prior FOMC meetings leading into the recent policy rate reduction. However, it is not clear when the anticipated stimulus will come, or of what size and strength it will be. Currently CME Group’s FedWatch tool predicts a 95% chance of a 25 basis point reduction to the federal funds target rate at the next FOMC meeting in September.
Although Jerome Powell did not explicitly provide an exact framework for monetary policy in the U.S., he did reiterate the biggest contributors to the uncertainty clouding what is otherwise a decent domestic economic environment. Giving Wall Street a few key issues to track will hopefully ease some of the wild ups and downs seen over the past few months. But most of the uncertainty comes from the White House and their ability to negotiate the deal with one of the largest trade partners of the U.S., China.To stay up to date with the latest news on the Fed and interest rates, stay tuned to our Insights page. If you need assurance that you are getting the most competitive rates on your deposits while keeping them secure, talk to ADM about our Deposit Management services.