Reactions to Fed Chair Powell's Speech

Like many of you, I watched Fed Chair Jerome Powell deliver his Jackson Hole speech this morning. It was short (though longer than last year’s) and mostly predictable. I wrote this post last week, noting:

I think it’s pretty easy to anticipate what Powell will say at this year’s gathering. We’ve made substantial progress. But there is more work to do. We are firmly committed to brining inflation all the way back down to 2 percent. We’re not going to declare victory and go fishing.

And that’s pretty much what we got. My own read is that Powell’s remarks leaned hawkish overall. So far, the market response is relatively muted. Nothing like the meltdown that followed last year’s uber-hawkish Pain Speech.

So What Did We Hear?

The Fed Chair repeated that it is the job of the Federal Reserve “to bring inflation down to 2 percent, and we will do so.” He noted that “inflation has come down roughly in line with global trends.” He made it clear that the Fed isn’t satisfied with where we are, and he said that “the process [of bringing down inflation] still has a long way to go.”

He noted the substantial progress in headline inflation (which has come down from its peak of 9.1 percent in June 2022 to 3.2 percent in the latest reading), but he added that “food and energy prices are influenced by global factors that remain volatile, and can provide a misleading signal of where inflation is headed.” So he mostly focused on core PCE, which is the Fed’s primary inflation target.

The text of the speech wasn’t made public until after his live remarks, so he raised some eyebrows when he said, “Core PCE inflation peaked at 5.4 in February 22 and declined gradually to 4.3 in July.” As JPMorgan’s David Kelly noted immediately following the speech, we won’t have July core PCE data from the BEA until 8:30 a.m. EDT on August 31. The last official read (June) came in at 4.1 percent.

But the text of the speech makes clear that 4.3 percent is the Fed’s estimate for July core PCE.

Looking at monthly data on core PCE, Powell said that “the lower monthly readings for core inflation in June [actual] and July [forecast] were welcome” but “only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal.” He described the outlook as “unclear” with respect to where underlying inflation will settle and that there is “substantial further ground” to get back to price stability.

And then he walked us through what’s been happening with the three broad components of core PCE inflation—inflation for goods, for housing services, and for all other services, sometimes referred to core services ex-housing. I won’t repeat it all here, you can read those passages of the speech or listen for yourself.

The hawkish tenor basically emanates from Powell’s observation that “the economy may not be cooling as expected.” He emphasized that GDP growth is running above trend and consumer spending has been “especially robust.” And even with the backup in long-term yields and the spike in mortgage rates, Powell recognized that the “housing sector is showing signs of picking back up.” He’s worried that all of this “could put further progress on inflation at risk and could warrant further tightening of monetary policy.”

Bottom line? Calls for a higher inflation target have fallen on deaf ears. Powell insists that the Fed can’t stop/won’t stop until inflation is all the way back down to 2 percent. It is an extremist policy commitment.

Getting inflation sustainably back down to 2 percent is expected to require a period of below-trend economic growth as well as some softening in labor market conditions.

Two percent is and will remain our inflation target.

The discussion then turned to real rates, which Powell notes “are positive and well above estimates of neutral.” This tells Powell that monetary policy is currently “restrictive” and it will need to stay restrictive until the Fed is convinced that inflation is on a durable path back down to 2 percent. The problem, Powell admits, is that “we cannot identify with certainty the neutral rate of interest,” nor does the Fed know how much “drag [is] in the pipeline” yet to be felt due to the variability of lags.

He closed with another nod to uncertainty and a commitment to “keep at it until the job is done.”

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Conclusion

My read on Powell’s read of the inflation outlook is that the Fed continues to believe—despite any evidence—that core services ex-housing (and in particular wage growth) could cause inflation to become persistent. The reality is that there aren’t that many parts of the economy that are very sensitive to interest rates, and inflation has mostly come down for reasons unrelated to tightening monetary policy.

It takes time for all of the elevated drivers of inflationary pressure to pass through and show up in the data. But it is happening. Patience is what we need, but the Fed appears committed to an extremist strategy in order to get all the way back to 2 percent inflation. As David Kelly noted this morning, that is an extremist commitment that risks sacrificing 1.6 million people at the alter of getting to 2 percent. “This is not,” as Kelley put it, “an inflation prone economy.”

Who in their right mind wouldn’t prefer an economy with 3.5 percent unemployment and 3 percent inflation to a collapse in the housing market and a full-blown recession?