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Powell Remains Defiantly Upbeat

RFP
The Federal Open Market Committee (FOMC) voted to hold its policy with regard to interest rates and asset purchases unchanged at the end of its meeting today. The statement accompanying the FOMC’s decisions to continue to support the economy suggests that committee members have decided to wait until at least September to make a decision on a tapering of its $120 billion per month in asset purchases - $80 billion in Treasury bonds and $40 billion in mortgage-backed securities. We expect that they will see enough improvement in labor markets to taper asset purchases by year-end. Fed Chairman Jay Powell made clear that they want to taper asset purchases before they raise rates.

Separately, the Fed made both of its repurchases facilities, domestic and foreign, permanent. That is important to the plumbing of financial markets, to ensure they don’t get clogged as the economy regains ground lost to the pandemic.

The Delta variant has introduced a level of uncertainty regarding the outlook but as Powell underscored, we have become used to living with the risks associated with COVID. He underscored that the economy has weathered each wave of the variant, despite the blow to our collective health. I would add, and he did mention, the caveat that much of the resilience we have seen was supported by fiscal policy. The last round of fiscal aid and stimulus hedged the downside risks of another outbreak, but we will reach a cliff on fiscal policy in January, even with additional spending for infrastructure. That is when expanded monthly child tax credits will expire.

Powell was pressed to put parameters on his definition of “transitory inflation.” He stressed the composition, where in the economy prices are accelerating, which is largely related to the pandemic. He cited vehicle prices, which are surging in response to computer chip shortages and disruptions in the global supply chain. That is something that should work itself out over time. In fact, consumers’ attitudes regarding buying a vehicle have soured since prices spiked. Other price increases are related to the rebound in service sector prices like airfares and hotel rooms, and largely isolated. A broader surge in inflation would change his mind with regard to the risks that inflation could become more entrenched.

He explained exactly what he meant by transitory. It is not a cessation of inflation or a drop in prices. Rather a slowdown in inflation to a more reasonable pace. He does not expect producers to roll back their prices per se; the key for him is that prices stop rising at the pace we have seen as the economy reopens. There is no precedent for reopening a $20 trillion economy all at once.

Powell stressed that the Fed will be watching long-term inflation expectations. As long as most consumers and businesses expect inflation to remain in the Fed’s long-term target range of about 2%, then the Fed will not worry. If those longer term expectations were to markedly shift, the Fed would be forced to move more aggressively, to taper rapidly and then raise rates.

Powell said, “We won’t have an extended period of high inflation. As the economy reopens...we will use our tools.”

Powell and his colleagues are expecting to see the labor supply, and many of the bottlenecks that have formed, to ease up as we get into the fourth quarter. He talked at length about some of the reasons why workers are not showing up as fast as many would like, given the push from employers to reopen. One of the largest hurdles to reopening is the fact that so many have been unemployed for so long. They have to go and find new jobs rather than just return to their old jobs. Many have left their former professions and are now seeking training after a delay due to the pandemic. Others have childcare responsibilities, which will hopefully dissipate once kids are back in school. All federally funded supplements to unemployment insurance will expire by the first week of September.

Bottom Line
Chairman Powell remains defiantly upbeat about the outlook, despite the emergence of the Delta variant. However, that optimism has not changed the trajectory for rate hikes. The Fed will wait until we see a few more good months of employment gains before tapering asset purchases and even longer before raising rates.

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