The dog days of August sent most sane people off to the beach these last few weeks, but we still wanted to make a couple of points about the Federal Reserve Bank of Kansas City conference in Jackson Hole later this week and what it may portend for the Federal Reserve’s near term policy path and messaging.
*** For all the anticipation of Fed Chairman Jerome Powell’s keynote speech this Friday to open Jackson Hole, we suspect he will avoid any overtly hawkish or dovish signals about the near policy path. As previewed by that “for now” inserted into his Capitol Hill testimony last month, and in line with the themes to this year’s conference on the “Changing Market Structure and Implications for Monetary Policy,” he is likely to instead highlight the near term challenges in sifting often conflicting data for the signals about the economy and inflation and, above all, the uncertainty bands around the current base case for a continued pace of gradual rate increases. ***
*** Powell’s likely cautious tone notwithstanding, barring a shock downturn in the outlook or markets, the Federal Open Market Committee is all but certain to increase the fed funds target by another 25 basis points to 2%-2.25% at the September 25-26 meeting. But the takeaway from Jackson Hole, we think, will not be about September, but in previewing the policy approach to December when, against the backdrop of hard-to-model cross currents of fiscal and trade effects, the Fed will be adopting more of a “data-trailing” risk management tact as it probes for a neutral policy stance where it could potentially pause with rates. ***
*** There is a clear FOMC desire for a rates pause once they are confident the policy rate is at neutral, and a September hike will bring the policy rate to the lower end of some short run R* estimates. But caution is not the same as dovishness, and while a pause by December is possible, it is hardly a given; if underlying inflation or inflation expectations look to be gathering momentum, the “for now” rates stance could give way to continued rate hikes in December and into next year, perhaps even at a quickened pace. All else being equal, the least likely rate path next year is for an extended pause or an outright end to the upward rate trajectory. ***
Likely Jackson Hole Themes
As a keynote to open the Jackson Hole conference, Chairman Powell’s speech on “Monetary Policy in a Changing Economy” is likely to hue closely to laying out the themes of the conference on the broad structural changes in the economy and markets and the challenges they present to monetary policy.
Among the likely topics of the academic papers will be examining the concentration of market share and pricing power with a handful of global-spanning corporations and banks, the complexities of global supply chains, and the impact of online sales to the brick and mortar retail sector and aggregate demand; the various panels are also likely to look at whether these broad changes to the corporate and market landscape may be effectively reducing competition, slowing business investment spending and productivity, or invariably shifting the balance of power from wage-earners to business firms.
Overall, it is pretty daring subject for the Kansas City Fed to tackle, as the discussions will no doubt venture over into the social and political ramifications of these structural changes. But the focus will invariably turn on how the market concentration and monopolistic behavior may be reshaping the dynamics of the inflation process.
How and in what way, for instance, all of this might be playing into the trend for low to flat wage growth across the US and developed economics these last few decades will be an obvious direction to the debates at the conference.
Likewise, corporate pricing power restrained by the pressures of these structural changes might go a long way to explaining the persistence of the low and inertial inflation despite a headline unemployment rate steadily dropping well below even the most dovish Fed estimates of NAIRU.
The likely thrust of the discussions at Jackson Hole in highlighting structural factors restraining wages and corporate pricing power up to now would generally seem to support the Fed’s assumptions for a tolerated, very modest rise in inflation soon nudging just above the 2% target, despite the strong fiscal stimulus this year and next. And, on balance, it could even be taken as signaling a dovish tilt to the Fed’s near policy path as it nears the end of its policy normalization strategy.
But if anything, the questions likely to be raised at Jackson Hole will be less about telegraphing the near term rates path as much as they will be underscoring the difficulties in the policy transition from the gradual pace of rates normalization to a more meeting-to-meeting, gingerly taken probing for a neutral policy stance.
That has a lot to do with our doubts Chairman Powell will necessarily intend an overly dovish takeaway in what we expect will be an accent on how wide the bands of uncertainty are around the base case for a continued pace of gradual rate hikes; caution is not the same as dovishness.
Navigating the Cross Currents
What’s more, that sense of caution is being driven by a particularly unusual confluence of cross currents expected in the data through at least year-end that will be just flat out hard to model in terms of their scale or timing.
In other words, if the task of the Fed forecasting staff is to rigorously sift through each week’s noisy data for the prized signals of statistical regularities that are freeze-framed every eight weeks or so for the FOMC to make a policy decision, that elaborate process is likely to become even more difficult this fall. In particular there are the uncertain effects of the Trump Administration’s fiscal and trade policies.
A probable majority of the FOMC and staff are now expecting a further uptick in fiscal spending in the fourth quarter of this year, as companies work out the details of their tax cuts and government agencies kick into a higher gear to spend their bigger budgets under the two year budget deal reached last spring.
The assumption for now is that the boost to demand will more or less “fizzle out, maybe by the end of next year. But that remains to be seen, and points to an upside risk in the forecast.
And when it comes to the trade effects, they can be a lot like oil in cutting both ways, denting growth in time but also pushing up inflation in the nearer term. Adding to the complications, there has in fact been so little in actual trade tariffs put into place, so most of its impact lies in the effects of the uncertainty on either front-loaded or delayed business investment spending.
To some extent, the Fed could potentially “look past” any upward pressures on inflation in either a strong fiscal stimulus or new trade tariffs as a one-off level effect. But with both coming when the economy is already operating above trend and near mandate-consistent levels of both employment and inflation, they are instead putting a high premium on decomposing inflation data over the next few months for signs of those “one-off” upward pressures seeping into underlying trend inflation measures, and in particular, threatening to untether anchored inflation expectations.
Inflation expectations are in some sense the new Phillips Curve in mapping out the inflation process, and likewise it is not so much the level of core inflation that matters — the Fed, after all, has made it clear it is willing to tolerate a temporary, accidental overshoot of the 2% inflation target — but its momentum: it won’t really matter as much if core PCE is 2.1% or 2.4%, if there is a sense of inflation momentum picking up going into the new year, be it trade or fiscally driven, the FOMC is likely to respond with a more hawkish posture.
But if inflation expectations look to be firmly anchored, even against the backdrop of a strong fiscal impulse to demand, the FOMC will have the luxury of more patience in assessing the inflation risk down the road, and thus more options on rate policy next year.
That, in essence, was the significance of the “for now” conditionality added to the current messaging for a continued gradual pace of rates normalization, and in turn, the desire for maximum policy flexibility beyond September. And that will likewise be, we think, the intended takeaway from Chairman Powell’s keynote on Friday.