Federal Reserve Chair Jay Powell's testimony on Capitol Hill this week was set up by Vice Chair for Regulation Randy Quarles when he stated that risks to the forecast are to the upside, given that headwinds are abating and factors to stimulate economic growth are emerging. There could not be a clearer signal that rate hikes this year may exceed the three currently planned. Raising rates at the March Federal Reserve meeting is all but a done deal.
The evolution of thought follows the January Federal Open Market Committee (FOMC) statement and minutes from that meeting, which revealed that members revised up their forecasts in response to the tax cuts. Indeed, upward revisions were made even before the budget agreement and continuing resolution, which will deliver the largest fiscal stimulus since the financial crisis. It is very late in the economic cycle to do this.
The FOMC may be too sanguine in its inflation assumptions, particularly given the administration's renewed commitment to tariffs and the NAFTA negotiations that are close to stalling. Tariffs would raise inflation faster without the offset of increased wages to support consumer spending.
The confidence about growth vs. recession is typical of the Federal Reserve and reveals the staff’s role in writing the economic speech for Powell, who is not an economist. Overconfidence in tame inflation is an area where previous Fed chairs have been burned (with the exception of former Fed Chair Janet Yellen). Ben Bernanke and Alan Greenspan both failed to see the imbalances associated with the housing market and keeping rates too low for too long. Muscle memory from the financial crisis and different business cycles would help.
Powell's decision to bring in two outside advisors who report to him directly speaks to his character. He knows the economists at the table will talk around him so he needs his own advisors to translate and balance the scales in setting monetary policy. This will be a crucial issue for him. We are in an environment with influential non-economists and a board that is severely understaffed. Powell lacks allies; that could give the regional Federal Reserve Bank presidents the upper hand influencing the trajectory of interest rates. Using translators will be critical for Powell to help him avoid missteps and lead, instead of following.
Powell’s first appearance on the Hill reflected the traditional stance of the Fed. I hope he shifts toward Main Street. I know that staff are looking into the rural/urban divide and worrying about the consequences of a shrinking labor force. Whether he sees that as a problem and shares Yellen’s concerns about those who have been left behind in the wake of the financial crisis is unclear.
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