Federal Reserve Chairman Jerome Powell’s breathlessly awaited keynote speech to open the virtual Jackson Hole conference this morning delivered in every way on the expectations of a foundational shift in the Fed’s reaction function going forward.
There is much to digest in where he chose to put his accent in the speech and the actual changes in the “Statement of Longer-Run Goals and Monetary Policy Strategy,” and of equal interest there are a dozen or so staff papers that provided the basis for the Federal Open Market Committee discussions and eventual consensus decision (the overview paper is “The Federal Reserve’s Review of Its Monetary Policy Framework: A Roadmap,” and it and all the papers cited can be found at the Board’s “Fed Notes” website).
But there are three broad takeaways for now that we would highlight from Chairman Powell this morning:
Creating the Option for September Guidance
** Perhaps the most important to markets in the very near-term is that by releasing the Longer-Run Statement in full today, rather than just previewing its highlights and holding the actual release until the next FOMC meeting, the Fed has in effect given itself the option to proceed with the new guidance on rates and the balance sheet at the September 15-16 FOMC meeting if warranted. The decision on the guidance will be based on the outlook and the efficacy of the transmission of the intended accommodation into the real economy, but on balance, we now think it more likely than not the new guidance will be rolled out in September’s post-meeting statement.
** We noted yesterday our sense that the Committee sentiments were tilted to a “two-step” process on the transition to monetary policy: to first unveil the revisions to the longer run statement that “serves as the foundation for our policy actions,” as Chairman Powell put it at the July meeting presser, and then to follow through with the more specific tactical policy guidance at a later meeting. Releasing the longer run statement in full now frees up the September meeting if deemed warranted, and in hindsight, it would have made no sense to merely preview its main points only to leave the market hanging and speculating over its final form for three weeks.
** If the new guidance is adopted in September as we now suspect is likely, the aggressive lower for longer rates guidance is already almost a given, and already fully priced into the market; likewise, while a decision on the exact amount of the large scale asset purchases or QE that would reinforce the rates guidance won’t be made until the meeting, whether working with the existing steady state of $80 billion a month in treasury purchases across the treasury curve to ensure market function or as an add-on to the current steady state purchases, it is fair to assume the average maturity of the QE will be pushed to the longer end of the treasury curve.
** Before we get too far ahead of ourselves on the guidance, however, it is worth cautioning that we do not have any strong sense the FOMC has worked out yet a consensus on the crucial thresholds: they are highly likely to be “outcome-based” and refer to both the inflation and employment mandates, but as the FOMC has just more or less discarded the Phillips Curve trade-off between inflation and employment, we are not quite sure how they will construct the thresholds. And indeed, albeit a far lower probability to be sure, there is a chance they might include a vaguely worded financial stability safeguard.
The New Definition of Maximum Employment
** On a more long-term policy level, the most immediate reaction we had when skimming through the new longer run statement was how the employment mandate was cited first and, relative to the more widely telegraphed and already priced-in change to an “average” 2% inflation rate “over time,” may be less appreciated in how far reaching the new definition of “maximum” may prove to be in its implications for monetary policy going forward.
** “The FOMC emphasizes in the new longer run statement that maximum employment is “a broad-based and inclusive goal” and that policy decisions going forward will be based on the “assessments of the shortfalls of employment from its maximum level” — previously the longer run statement cited “deviations from its maximum level.” In other words, so long, NAIRU and the Phillips Curve.
** The Fed in effect, has formally adopted a truly symmetric inflation target as everyone expected, on the one hand, but it went very asymmetric on unemployment. It may mean little when headline unemployment is at the current 10% levels, but it could become hard to exit from and a very big deal — and a big political deal – when or if inflationary pressures are higher but the headline unemployment rate, while invariably lower, may not be low enough for minority group unemployment or participation rates.
** Not to spoil the dovish takeaways going forward, but the discarding of NAIRU and Phillips Curve trade-offs does bring to mind a paper cited by Chairman Powell in one of his recent speeches by Athanasios Orphanides and John Williams from 2011 on the “Monetary Policy Mistakes and the Evolution of Inflation Expectations.” They argued that much of the Great Inflation of the 1970s was rooted in the “New Economic” activism of the mid 1960s, in which the bet was made low inflation could be maintained while running the economy hot enough to get unemployment even lower.
** There is a handful of Fed staff and Committee members who, despite the consensus behind the longer run document, still worry that the inflationary pressures of an economic rebound stronger than forecast or fiscal policy whose scale and stickiness is larger than presumed, could still lead to a higher and sooner than expected inflation challenge. Perhaps then, it is a good thing the FOMC also committed today to a review of the framework every five years.
Financial Stability on the Radar Screen
** And one other takeaway we would highlight is how the FOMC has managed in a low-key way to slip in its concerns for financial stability. Powell snuck in a mention of financial stability in an ultra-loose great moderation low rate environment right at the top of his speech, it drew a strengthened mention in the longer run statement, and in the slew of staff papers also released today, an important paper on “Monetary Policy Strategies and Tools: Financial Stability Considerations” was also included.
** We don’t want to lean on the financial stability debate too hard – not yet – more or less because we don’t think Chairman Powell, or the Committee majority, are very keen to tackle the issue any time too soon. But we do think it will be increasingly the subject matter of more research papers and, in time, perhaps of more Committee speeches on the financial stability issues in the run up to the November release of the updated Financial Stability Review and the scheduled co-hosted conference on bank supervision in December.
** In that scheme of things, as former Chair Janet Yellen once remarked, “pick the timing of your battles if you can,” and in that sense elevating the concerns over financial stability risks in an extended period of low rates too highly could present a hardly ideal “own goal” of creating undesirable market turbulence (i.e. the December 2018 FOMC presser messaging mishap). What’s more, expounding on that theme amid a massive run up in stocks two months before a volatile presidential election probably would not be politically prudent. So silently and gently is the approach, we think, but the issue is on the radar screen, and may play into the messaging as the expiration of the 13-3 credit facilities approaches at year-end.
A Geared Up Communications Campaign
** In the meantime, the Fed’s messaging priority in the near term will be on the dovish implications of the new longer run reaction function that should lift inflation expectations, and perhaps as soon as the September meeting, the adoption of new monetary policy rates and balance sheet guidance.
** On that communications front, there is a high profile slate of Fed speakers ready to drive home the messaging of the new longer run statement, and we suspect, the conditions under which the FOMC would adopt a new rates and balance sheet guidance on its near-term policy stance going forward.
** First up on Monday after the Jackson Hole discussions today and tomorrow is Vice Chairman Richard Clarida, who husbanded much of the framework review to its completion today, with Governor Lael Brainard joining former Chairs Janet Yellen and Ben Bernanke in a one day conference on Tuesday, Federal Reserve Bank of New York President John Williams on Wednesday, and Federal Reserve Bank of Atlanta President Rafael Bostic following soon after.