For all the restless anticipation for Federal Reserve Chairman Jerome Powell’s keynote speech to open the Federal Reserve Bank of Kansas City’s “Challenges to Monetary Policy” conference in Jackson Hole this morning, the Chairman looks to have risen to his immediate communications challenge in laying out “how, in this low r* world, the Fed can best support the economy” when “fitting trade policy uncertainty into this framework is a new challenge.”
*** On balance, we believe Chairman Powell speech points to a high likelihood for at least a 25bp rate cut at the September 18-19 Federal Open Market Committee meeting. As we wrote earlier this week (SGH 8/21/19, “Fed: A Minute on the Minutes”), September will follow the July cut as the second to a two-step reset of policy back below a short run r* near 2.5%. We also think a larger but lower probability 50bp rate cut will be on the table if an FOMC majority of voters conclude US growth is at serious risk of deteriorating further in the wake of the US-China trade war escalation. ***
*** We would add that Chairman Powell’s carefully positioned repeat of the “act as appropriate to sustain the expansion” language is also leaving the door “ajar” to even more aggressive rate cuts if the trade war breaks the slowing momentum to US growth, elevates market volatility, or sharply spikes the risk probabilities around the base case outlook. But we suspect the Chairman is restrained from a more explicit “whatever it takes” messaging to avoid a “perverse feedback loop” in accommodation becoming negotiating leverage in the very trade threats causing the economic weakness. ***
*** And finally, we read the Chairman’s repeat of the conditional “with a strong labor market and inflation near its symmetric 2 percent objective” in the “act as appropriate” language against this trade war backdrop: barring a rapidly darkening outlook threatening systemic dislocations, we think the Fed’s increasingly risk-management, probabilities-driven policy will translate into a more lagged reaction function in waiting for the political cover of clearer evidence in the data of slowing growth before easing further beyond September’s likely accommodation. ***
Three Weeks since July
Wrapping a thoughtful account of the three eras where in each case monetary policy faced a different challenge, Chairman Powell noted “the three weeks since our July FOMC meeting have been eventful” citing a fairly long list of geopolitical risks to the forecast, including a hard Brexit, Hong Kong, even the fall of the Italian government, on top of slower growth in Germany and China. In other words, the outlook has turned darker since the FOMC “insurance” rate cut in July, and tellingly, he opened the list of the eventful weeks with “the announcement of new tariffs on imports from China.”
In asking in the money takeaway paragraph “how, in this low r* world, the Fed can best support the economy” when “fitting trade policy uncertainty into this framework is a new challenge,” Chairman Powell gave a careful answer, meant to be as reassuring as he can afford to go by affirming the Fed will “act as appropriate to sustain the expansion” that is clearly slowing and under duress.
Almost on cue, after an immediate, surprisingly ugly tweet accusing the Chairman (misspelt as “Powel”) of being an “enemy” and comparing him to China’s President Xi Jinping, President Trump ramped up the trade war rhetoric promising to retaliate to the Chinese tit-for-tat threats to retaliate to the President’s September 1 higher tariffs. The escalation has sent the markets into another nosedive that is all but overshadowing Chairman Powell’s carefully reasoned case.
Bullard’s Tactical Positioning
We also found it interesting that Federal Reserve Bank of President James Bullard used a pre-Powell speech appearance on CNBC to tactically set the contours to a likely consensus to a September 25bp rate cut.
Bullard was previously pushing back against a 50bp rate cut and arguing for the 25bp cut in July, making the case for it to be likely followed by a second 25bp rate cut in September. We suspect he is putting a 50bp on the table in September for two reasons.
First, the case for a 50 rather than 25 in September is being driven by the growth outlook since the July meeting further deteriorating due to the escalation of the trade wars, which would be pulling down the short run r* down and calling for a bigger insurance policy to keep policy accommodative.
But second, and in a way, more interestingly, by shifting the center of the FOMC policy debate in September from a 25bp rate cut to putting the case for a 50bp rate cut on the table, it in effect is tactically leaving room for the more reluctant or hesitant Committee members to cede ground on a 25bp rate cut. In terms of the committee dynamics, it may have the effect of isolating the two dissenters, or even pulling one of them into withdrawing a dissent even if they do not vote for a rate cut.
That seems even more likely to us when a large majority of the Committee is already largely in agreement the short run r* is drifting lower; and reflecting that, we suspect the median growth outlook is likely to be marked down in the next round of the Summary of Economic Projections at the September 19 FOMC meeting.
That, we think, may prove especially to be the case if, as we believe, President Trump sticks to the implied threat for additional retaliation on top of the September 1 higher tariffs on Chinese imports, and the Chinese likewise follow through with their own vowed retaliation (see SGH 8/16/19, “China: Beijing’s Response to Trump”).
Door to Deeper Cuts Remains “Ajar”
The other takeaway we read into the Chairman’s speech is the implicit signal in his carefully placed repetition of the “act as appropriate to sustain the expansion” phrasing literally at the end of the money paragraph for heightened emphasis.
As we wrote in an earlier report (see SGH 7/26/19, “Fed: The July Cut”), we strongly believe Chairman Powell is broadly hinting as much as he can or is willing to go in providing a reassuring “we will have your back” to the markets and the real economy.
What, we think, is preventing a clearer or sharper communications on the possibility for a more aggressive reaction function to elevated risks along the lines of the so-called Reifschneider-Williams playbook of “swift, aggressive, and pre-emptive” rate cuts is the increasing reluctance to see monetary policy being drawn into the vortex of trade policy as negotiating leverage to a tit-for-tat ratcheting up of trade pressures that in turn, drive the lower growth the Fed is trying to offset.
How exactly Chairman Powell and his FOMC colleagues overcome that challenge is perhaps the most pressing one of the long list of challenges to current monetary policy that will be laid out and discussed in the next two days in Jackson Hole.