Blonde Money: Down the J Hole with the J Pow

There couldn’t be a better sign of the predicament in which the Fed finds itself than this year’s Jackson Hole symposium. The annual conflab for the world’s central bankers has suddenly gone from a long weekend of huntin’ and fishin’ in the wilds of Wyoming to a virtual one-day webinar, all thanks to the Delta variant. Hope springs eternal but Fear persists. Powell recently admitted as much himself, warning “the pandemic is still casting a shadow on economic activity, we cannot declare victory yet”. Not all of his colleagues agree. Recent Fed pronouncements have taken a distinctly hawkish turn, with the highest inflation rates in thirteen years scaring a number of FOMC members that they’re running the economy too hot. So which way will the J Pow turn when he goes down the J Hole – a dove who fears the job is not yet done, or a hawk who needs to remove monetary stimulus ASAP?

The rebel hawks

The Fed is famously not a democracy but neither is it purely the work of just the Chair. There is usually a centre of gravity that forms around the Chair, comprised of a few key lieutenants. Quarles and Clarida have taken on this role under Powell but even as he attempts to retain his dovish colours, they have pivoted to hawks.

  • At the end of May, Quarles made a speech embracing reflation, noting his optimism that ‘we are poised to enter a robust and durable expansion’.
  • At the beginning of August, Clarida sounded the alarm on inflation, noting ‘if, as projected, core PCE inflation this year does come in at, or certainly above, 3%, I will consider that much more than a “moderate” overshoot… and I believe that the risks to my outlook for inflation are to the upside’
  • In between these two speeches, we got the infamous June dot plot, where the Summary of Economic Projections showed six more of them expected rate hikes in 2023 than they had the quarter before

Quarles and Clarida have read the room. And the room is now more worried about overheating inflation than anything else.

The FAIT Accompli

The Flexible Average Inflation Targeting regime introduced at last year’s Jackson Hole has barely survived one year. That framework was supposed to let inflation run high while the economy overheated, precisely so that it would reduce a shortfall in employment. And not just overall employment, but jobs for everyone. Brainard, Daly and Bostic have been at pains to point out that although jobs are coming back, they’re doing so more slowly for minority groups. But as Kashkari recently noted, the Fed must “pay attention to… the inflation side of our dual mandate” as they “do not have the ability of targeting, for example, the Black unemployment rate”.

The tapering dove

So the inflation bear is at the door. The latest Fed Minutes show most participants “judged that it could be appropriate to start reducing the pace of asset purchases this year”. Given the painful experience of 2013’s taper tantrum, they will want to signal ahead of time what we should expect the taper to involve so that there are no nasty surprises. The market has helped them out on this front, given the US 10 year yield has fallen from 1.50% at the end of June to 1.25% now, giving ample room for yields to spike up without doing too much damage. So we can expect a further nudge towards a taper when Powell speaks at 3pm London time on Friday.

It will only be a gentle nudge. If he’s too aggressive in signalling the pace at which asset purchases will be reduced, the market will bring forward their expectation of interest rate hikes. Powell knows this is not the moment for tighter financial conditions. The Delta variant has swept across America, just as it has across the rest of the globe. It has already caused the New Zealand central bank to delay their first rate hike, given their meeting came the day after a snap lockdown began. Powell doesn’t want to frighten the horses. The American consumer is already wobbling: the Michigan Consumer Sentiment survey this month suffered the third-largest drop in its half-century history.

Powell also has a personal stake in the game. His term as Chair of the Fed expires early next year and his reappointment lies in the hands of Biden and the Senate Democrats. As BlondeMoney explained in our piece on the 8 Crucial Senators who hold the balance of power in a 50-50 split Senate, there is currently a monumental battle taking place for the soul of the Democratic Party. On the one side there are the progressives who mourn that Biden hasn’t been left-wing enough, and on the other the moderates who fear too large a price tag for such profligacy. None of them would be very happy if interest rates were to rise too quickly.

Powell then will strike the politically delicate balance for which he is renowned and emerge as a dove.