The list of policy-makers who did not attend the Jackson Hole symposium in August makes it look like President Donald Trump imposed a tariff on central bankers entering the US. Missing in action were the heads of the European Central Bank, Bank of England, Bank of Japan and Swiss National Bank – managers of the main currencies, besides the dollar, in the foreign exchange market.
As it was, Federal Reserve Chair Jay Powell had centre stage to himself. His speech was hailed as a stirring defence of central bank independence, though had he delivered it a few weeks earlier it would have looked like an anodyne description of Fed policy.
The US economy continues to demonstrate robust growth, Powell said. There is no sign of excessive inflation, and unemployment is at record lows. The Fed will continue to walk the narrow path of gradual rate increases, neither encouraging inflation with easy money nor curbing growth with premature tightening.
The speech took on heightened significance against the backdrop of Trump’s stated unhappiness that the Fed is raising rates. Traders took the speech as an assertion of Fed independence and pushed stock markets to new highs.
This may be what Powell intended. But, at the beginning of his speech he cautioned, ‘As always, there are risk factors abroad and at home that, in time, could demand a different policy response.‘ Although this could look like a standard disclaimer, it took on added significance in the context of Fed concerns over trade tensions.
The minutes of the FOMC meeting in late July hinted that disruptions in global trade could prompt policy changes. The Fed might skip the widely expected rate increase in December if clashes created enough uncertainty around future US growth. Analysts consider a rate rise in September inevitable, especially since the Fed cannot be seen as bowing to White House criticism.
A fourth rate increase this year, however, is contentious. A slim majority of FOMC members indicated four increases in the dot-plot graph that is published every other Fed meeting. Whether this change when the next graph is released will get more attention at the September meeting than the rate rise itself.
At Jackson Hole, Powell acknowledged the inverse relationship between unemployment and inflation embodied in the Phillips curve seems to have disappeared: ‘Inflation may no longer be the first or best indicator of a tight labour market and rising pressures on resource utilisation.’ Rather, ‘destabilising excesses‘ in financial markets were the lead indicators in the last two recessions. ‘Thus, risk management suggests looking beyond inflation for signs of excesses,‘ he concluded.
This view allows the Fed to proceed with rate increases even in the absence of inflation. But it also cuts the other way, so that St. Louis Fed President James Bullard, for instance, can insist the Fed should not proceed with any further increases with inflation in abeyance.
At Jackson Hole, Bullard warned against raising rates: ‘We would be deliberately inverting the yield curve, because we think our models are right and we think the market’s wrong… We don’t have to do that, we don’t have to walk the plank in this situation because inflation is not high.‘
A debate on the significance of the yield curve appeared in the recent FOMC minutes. Some participants feared that an inversion – when short-term rates exceeds long-term rates – would herald a recession. Others argued that this historical signal no longer applies and that there are numerous reasons for long-term yields to remain low, such as investors seeking safe assets amid trade tensions and even central bank bond purchases.
Other FOMC members are more hawkish. Esther George of Kansas City and Loretta Mester of Cleveland see strong growth as a reason to continue raising rates. George suggested there should be two more increases this year and perhaps ‘several more‘ next year. Mester said she has been raising her GDP forecast. Tax cuts spurred growth, she said, adding, ‘There’s been more momentum in the economy than I might have anticipated… Right now, this gradual upward path of policy rates seems appropriate.‘
Robert Kaplan, head of the Dallas Fed, was more cautious, as he sees interest rates approaching the neutral level where they neither encourage nor stifle growth. ‘It would take approximately three or four more federal funds rate increases of a quarter of a percent to get into the range of this estimated neutral level,‘ he said in an essay. This would be fewer than predicted by George and fewer than the six potentially pencilled in for the remainder of this year and 2019, which is shaping up to be an especially fretful time for US policy-makers.
Darrell Delamaide is a writer and editor based in Washington.