Fed: Celestial Stars

Published on August 24, 2018

A quick reaction on two points to the keynote speech by Federal Reserve Chairman Jerome Powell this morning in Jackson Hole:

*** First, we honestly did not see the speech as especially dovish, which is how the markets and media seem to be taking it, nor for that matter, not very hawkish either; instead, as we tried to highlight last week (see SGH 8/20/18, “Fed: Jackson Hole, For Now”), we thought it was all about laying out the risk management tact the Fed will be adopting in the near term. ***

*** Second, against the backdrop of that approach, caution is not the same as dovishness, and we suspect for now that unless the data veer too far below or above the base case forecast, the “lean” within the Committee is for one more hike in December on top of the fully priced hike for September, especially if you take the risk of financial market excesses into account. ***

And as a third point, from a stylistic viewpoint, we have to say it was a well written and well laid out speech, both in defending the Fed’s current, cautiously taken gradual pace of rate hikes on the way to wherever the heck neutral is, and in coming up with a new narrative metaphor — navigating amid shifting “celestial stars” — to describe the Fed’s policy framework that hopefully replaces the “headwinds” and “tailwinds” long past their sell-by date from the Greenspan era. It is easily Powell’s best speech to date, and it will probably define his “helmsmanship” of the Federal Open Market Committee going forward.

Asymmetrical Risk Management

The “risk management amid shifting stars” that Powell was describing is only dovish in the sense that the initial risk management approach is almost by definition dovish in its implied asymmetrical reaction function (“whatever it takes” in the face of a collapse in demand and inflation versus a modest quickening in a gradual tightening if inflation expectations start to move too much).

And a risk management approach, Powell looks to have wanted to add, entails “looking beyond inflation for signs of excesses” or that is, we think he is suggesting, excesses in financial market as well as inflation in the real economy.

So that risk management tact can be dovish or hawkish in its meaning, we would suggest.

What’s more, beyond that tactical near-term approach, we think Powell is positioning policy to go in any one of alternative paths as the FOMC nears neutral and is weighing whether it can afford to pause in order to get a lay of the land and to gauge the effects of the accumulative rate tightenings since December 2015.

In his speech, Powell was also carefully striving, we think, to take into account the full range of views within the Committee and by doing so, to keep the Committee consensus intact with all its members on board until the moment of decision arrives.

On balance, we think that beyond the Jackson Hole debates, a September rate hike remains a near certainty, with more of the debate then revolving around the messaging going forward to the turn of the year.

The December “Lean”

And while the FOMC’s rate decision will become a tad more complicated and cautiously taken in the run up to the December meeting, we suspect the “lean” within the Committee is for one more hike in December (or January), unless the data veer too far below or above the base case forecast.

On that point, by the way, we thought the Chairman’s footnote 3 was interesting in his essentially brushing aside the debate between the lower short run R* and its higher longer run estimates that would, all else being equal, pose a strong argument for extreme caution in a rate increase beyond September.

But next year, and with the luxury of “live” meetings eight times a year instead of just four, Fed rates moves will in any case be more nimbly and gingerly taken, with a premium on policy flexibility.

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