Jay Powell performed well in his debut performance last week before Congress as Federal Reserve chair. He deftly evaded questions with doubletalk and moved markets as much by his demeanour as by his words. The word he used was ‘gradual’, referring to interest rate increases, but what the market heard was ‘faster’.
‘While many factors shape the economic outlook, some of the headwinds the US economy faced in previous years have turned into tailwinds,’ Powell said in the Fed chair’s twice-yearly testimony. ‘In particular, fiscal policy has become more stimulative, and foreign demand for US exports is on a firmer trajectory.’
Markets began marking up Treasury yields even as he spoke. ‘In gauging the appropriate path for monetary policy over the next few years, the Federal Open Market Committee will continue to strike a balance between avoiding an overheated economy and bringing personal consumption expenditures price inflation to 2% on a sustained basis,’ he said.
Powell referred to the inflation index, personal consumption expenditures, which the Fed prefers to the consumer price index, though the latter normally makes the headlines. In particular, the ‘core’ PCE, which strips out volatile food and energy prices, is the one on which the Fed relies.
That index tends to run a little lower than the CPI, and was the subject of some discussion in the January meeting of the FOMC. PCE price inflation was 1.5% in December, up 0.2 points from the summer low, prompting some to see a rising trend. But the data showed ‘few signs of a broad-based pickup in wage growth’, according to the minutes.
On employment, the 4.1% jobless rate remained near the lowest level in the last 20 years. Even broader measures of unemployment – such as the U6, which measures involuntary part-time employment – had returned to pre-recession levels. However, ‘a few participants’ still saw signs of labour market slack at the margins, such as the absence of significant aggregate wage growth.
Randal Quarles, the Fed’s vice-chair for supervision since October 2017, weighed in with comments. ‘The economy appears to be in a good spot right now,’ he said last week at the annual National Association for Business Economics conference. He welcomed the stimulus from President Donald Trump’s tax reform and said the budget proposals were ‘likely to impart considerable momentum to growth over the next couple of years’. However, he worried that the deficits they engendered, in addition to growing federal debt, could push up interest rates and crowd out productive private investment. ‘These effects will require attention and difficult decisions at some point,’ he warned.
Market consensus is hardening around the expectation that the Fed will increase the pace of interest rate rises. Some expect it to amend its dot-plot of interest rate projections to show four increases this year instead of the three observed in December. Almost everyone expects the FOMC to raise rates by 25 basis points at its next meeting on 20-21 March.
William Dudley, head of the New York Fed, weighed in on an unusual topic – the size of the Fed’s balance sheet when it is done unwinding the asset purchases it made to counter the financial crisis. Dudley said the balance sheet would be nowhere near the $800bn of the pre-crisis Fed, and may even be higher than the $2.9tn predicted in a report presented by four economists at the Chicago Booth monetary policy forum, where he made his remarks. The Fed, which has been slowly winding down its balance sheet from a peak of $4.5tn, will want to keep a large amount of excess reserves in the system to keep a floor on interest rates, Dudley suggested.
At the same conference Eric Rosengren, Boston Fed chief, said making further large-scale asset purchases would remain available to the Fed. Productivity and labour force growth are lagging, leading to low real rates, he said. The FOMC’s quarterly summary of economic projections puts the median long-run fed funds rate at just 2.8%, less than the Fed usually lowers nominal rates in a recession. This means asset purchases may once again prove necessary.
Darrell Delamaide is a writer and editor based in Washington.