(Forbes) In what could be his final annual speech leading the Federal Reserve, Fed Chair Jerome Powell delivered a robust defense of the central bank’s monetary policy in the era of Covid-19 while acknowledging that it could reduce the pace of bond purchases toward the end of 2021.
Powell’s nearly 30-minute talk at the Jackson Hole economic policy symposium was a remote affair. The rise of the delta variant forced the Kansas City Federal Reserve, which hosts the annual conference, to change its plans on short notice and hold a virtual event. The last-minute change only underscores the uncertain environment the Fed is navigating today.
In his speech, Powell reiterated his commitment to easy money as the nation continues to convalesce from the novel coronavirus. His comments immediately helped push stock indexes higher and drive down the value of the U.S. dollar versus other currencies.
“An uber-dovish speech from Jerome Powell has equity markets setting new all-time highs,” said Cliff Hodge, chief investment officer for Cornerstone Wealth. As for the longer term effects of Powell’s speech, here are three takeaways.
1. Jobs Are Recovering But Have Further to Go
Powell began by recapping the extraordinary nature of the Covid recession: The downturn was exceedingly quick yet devastatingly deep, causing almost 30 million people to lose their jobs in two months. The anticipation of this economic devastation was why the Fed cut interest rates to near zero in March 2020 and began buying $120 billion of debt each month.
Yet the bounce back has been better than many experts thought possible.
“[T]he pace of the recovery has exceeded expectations, with output surpassing its previous peak after only four quarters, less than half the time required following the Great Recession,” Powell said.
That recovery has been highlighted by impressive recent jobs reports: In July alone, employers added nearly 950,000 workers and the unemployment rate fell to 5.4%. The pace of employment should only pick up in the months to come, thanks in part to everyday life returning to a semblance of normal and higher federal unemployment insurance ending soon.
“With vaccinations rising, schools reopening and enhanced unemployment benefits ending, some factors that may be holding back job seekers are likely fading,” said Powell. “While the delta variant presents a near-term risk, the prospects are good for continued progress toward maximum employment.”
Still, Powell sees more room for improvement. There are about 6 million fewer people employed now than in February 2020, with 5 million of that total coming from the service sector, which was hit hardest by the economic lockdowns imposed after Covid-19 became a pandemic.
2. Inflation Is High, But the Fed Still Feels Confident
Employment was the uncontroversial part of Powell’s speech as the facts of the labor market aren’t really debated. The other half of the Fed’s dual mandate, inflation, has become much more contentious.
That’s because prices have risen more quickly than the Fed imagined they would. For instance, in March 2021 the Fed believed that inflation, as gauged by its preferred metric, the personal consumption expenditures price index (PCE), would rise by 2.4% for the year (and by only 2.2% when you strip out volatile food and energy prices). That estimate turned out to be wildly incorrect.
In July inflation rose by 4.2% compared to a year earlier while core inflation jumped by 3.6%. Those readings dovetail with broader measures of inflation, like the Consumer Price Index (CPI), which also show prices rising dramatically.
Powell has maintained throughout 2021 that this inflation pop is “transitory,” and he did so again in his speech.
“Inflation at these levels is, of course, a cause for concern,” Powell said. “But that concern is tempered by a number of factors that suggest that these elevated readings are likely to prove temporary.”
He defended that stance in five points:
- Inflation is mostly occurring in a “narrow group of goods and services that have been directly affected by the pandemic and the reopening of the economy.” Think hotel prices: They dropped a lot after the economic lockdowns of 2020 and are now moving toward more normal levels, making it seem on paper that their price has risen substantially.
- Among some products that have seen a high run up in prices, inflation seems to be moderating. Consider used car prices. They shot up in recent months as demand increased but supply was low. If those prices start to trail off, that will cause inflation overall to drop.
- There have been no crazy wage gains. Don’t get him wrong, Powell wants people to get raises. But he wants those raises to be in line with the Fed’s inflation target of 2%. So far, Powell hasn’t seen a “wage-price spiral” that’s a signal of sustained inflation.
- Longer-term inflation expectations are relatively normal. A whole range of surveys and forecasts expect 10-year inflation to grow at or near the Fed’s 2% target.
- Long-term trends still apply. For the better part of 30 years, inflation has risen below 2% in mature economies, even in boom times, thanks largely to globalization, technology and an aging population. These trends won’t suddenly disappear.
Given the progress that’s needed in employment, and the weird nature of the current inflationary moment, Powell argued to forge ahead with a dovish, expansionary monetary policy.
Nevertheless, there are worrying trends. For instance, consumer sentiment fell by 13.4% in August from a month earlier, driven by “rising inflation, small wage gains and slower declines in unemployment,” according to Richard Curtin, an economist and research professor at University of Michigan.
While the economy may continue to heat up despite the increase in cases driven by the delta variant, it seems at least possible that cities and states would impose further social distancing restrictions once cases rise in their particular region.
And what if inflation just isn’t as transitory as the Fed believes it is?
3. Tapering May Start by the End of 2021, But Don’t Expect Rate Hikes Soon
The conversation around the Fed has been dominated for much of this year by when it’ll start buying fewer bonds, a move known as tapering. Powell has not wanted to overreact to what he sees as temporarily high inflation, but he is open to the economy being healthy enough to eventually resume more normal behavior.
In his speech, Powell made clear that he and the Fed would continue to discuss when it would be appropriate to taper bond purchases, depending on how the economy is faring in the fall. But market observers now expect an announcement the next time the Federal Open Market Committee (FOMC) convenes in September.
“The Fed is still likely on pace to announce plans to taper in the coming months with the actual tapering process to begin either later this year or early next year,” said Lawrence Gillum, fixed income strategist for LPL Financial.
Whenever the Fed announces the beginning of tapering, though, don’t expect rate increases to occur anytime soon.
“The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test,” Powell said.
That won’t stop people from asking, though, said Tom Stringfellow, chief investment strategist at Argent Trust Company.
“As soon as they start tapering, the next headlines will be, ‘Oh my god, they’re tapering,” followed by questions of when rates will start moving,” Stringfellow said. “I think Powell did a good job of saying one does not influence the other.”
Perhaps a decision on when rate increases could be expected will be announced at next year’s Jackson Hole summit. Whether Powell is there (either in Wyoming or via computer screen) remains to be seen.
