Powell Keeps His Powder Dry

The Federal Open Market Committee (FOMC) upgraded its assessment of economic conditions in its statement on policy today but unanimously held the line on interest rates. Ramping up vaccinations and unprecedented fiscal stimulus, including two rounds of stimulus checks, spurred growth in the first quarter. Retail sales, employment and housing all accelerated with only a minor setback due to unusually bad winter weather and widespread power outages in the oil patch in February. Inflation is starting to pick up. The FOMC affirmed members’ belief that any near-term flare in inflation that we see will be attributed to transitory factors, and therefore should not affect short-term rates. The Fed wants to see “substantial further progress” in employment before raising rates.

Federal Reserve Chairman Jay Powell underscored that the Fed is committed to overshoot a bit on inflation after a long time, nearly a decade, of undershooting its inflation target. He would not view an overshoot of the Fed’s 2% target in 2021 as meeting that requirement. Powell also said it is “not time yet” to start talking about tapering asset purchases. We still need to see much more improvement in employment before the Fed considers a discussion about a potential taper. It is currently purchasing $120 billion per month with $80 billion in Treasury bonds and $40 billion in mortgage-backed securities.

Overall economic growth will easily cross the peak we reached in the fourth quarter of 2019 in the second quarter of 2021. Data on the first quarter is due out tomorrow; it appears that growth accelerated at close to a 7% pace after nearly screeching to a halt at the end of 2020. We averted a double-dip recession by ramping up vaccinations and massive emergency aid and stimulus. The economy is poised to post the strongest annual growth since 1984 this year after contracting sharply during 2020. The recovery in employment, however, is lagging that in the overall economy. A rising tide has not lifted all boats. Powell emphasized multiple times that we are still down about 8.5 million jobs from the pandemic.

Bubble? Powell addressed concerns about affordability in the housing market. He pointed out that the mortgages that are currently being underwritten are much better quality than they were leading up to the global financial crisis. However, the Fed is watching the surge in housing prices; affordability for entry-level buyers is becoming a problem.

Tight Labor Markets? Powell was questioned about why some workers are not coming back to work yet. He listed a litany of issues that are unique to the pandemic: lack of child care, fear of contagion, access to vaccinations and a jump in retirements at the onset of the crisis. These are all constricting the supply of workers. He noted supplements to unemployment insurance as a lesser factor that is scheduled to run out in September. We still are not seeing the kind of rise in wages that would be consistent with a tight labor market. Complaints of labor market tightness were common in the aftermath of the last recession but did not show up in wages until almost a decade after the recovery started. It took tight labor markets for employers to cast a wider net to find workers.

Powell noted that many of the Fed’s sources have adopted existing technologies that are boosting productivity growth, even in the service sector. Those increases in productivity growth, particularly at large firms, are likely to preserve profit margins and dampen the need to raise prices even as some wages go up. Rising wages at large employers have spillover effects on smaller employers who are unable to absorb those shocks. Those shifts, coupled with the business failures triggered by the pandemic, have wiped out “the work of generations.”

Powell was asked directly about criticisms from former Treasury Secretary Larry Summers that inflation will become more of a problem, like the 1970s. He reiterated the Fed’s understanding of base effects and bottlenecks. The Fed knows that the base effects will disappear in a few months. It is less clear how long it will take for bottlenecks to dissipate. If the Fed is wrong in its assessment, and inflation picks up in a more sustained way, it will deal with it. “We know our job; we will do our job,” he said in response to Summers.

Powell was asked about going to the homeless encampment that is near his office that he said keeps him awake at night on 60 Minutes. He said he will visit it but “not in the public eye.” He talked about his previous conversations with homeless people and why that’s important. “Homeless people...that could be you, your sister, your kid,” he said. I have never heard a Fed Chairman speak so compassionately about the most marginalized of workers. Refreshing.

Bottom Line
We were in a deep hole a year ago. We are finally rebounding with vaccinations and record stimulus, but it will take time. The Fed has decided it is more willing to risk a bit of overheating than derail a burgeoning boom. We need a boom to recover what was lost to the crisis, and get back to our pre-pandemic trend.

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