A quick note on Federal Reserve Chairman Jerome Powell’s testimony later this morning before the House Financial Services Committee:
** Chairman Powell’s primary aim will be to stick as closely as possible to a carefully scripted message of policy continuity in former Chair Janet Yellen’s gradualism in raising rates. For this year, that translates into the already well-telegraphed three rate hike base case, with the option of a fourth, if necessary, that he will do his best to frame as still a gradualist pace.
** We do not expect any intended hawkish signaling beyond the “or four” optionality, and any excessively hawkish market takeaway would trigger a corrective messaging in Thursday’s Senate Banking Committee testimony. If the Chairman doesn’t seem to be endorsing a higher probability for that fourth rate hike, the markets may take the testimony dovishly, which we suspect Fed officials will take in stride.
** The speech by Randal Quarles, the Vice Chairman for Banking Supervision, at the National Association of Business Economists yesterday afternoon struck us as an especially interesting preamble to the Powell testimony. In one sense, Quarles, a Trump appointee, seemed to push hard, almost too hard, in making the Trump Administration’s case the tax cuts will lead to higher productivity and higher trend growth.
** But in linking that pay-off — more “a clear possibility than an unarguable reality” — Quarles went straight to the point that it would also suggest the neutral rate is also rising that would still require higher rates just to keep pace with the intended gradual removal of monetary accommodation. So either way, the Fed will still be raising rates; it is just that the higher rates won’t be meant to slow the economy or undercut the tax cuts.
** In that, it struck us that his speech was aimed at an audience down the road at the White House as much as it was the conference attendees at the Capitol Hilton. In doing so, Quarles was playing a classic “wingman” role for Chairman Powell in providing political cover for what Powell may not say so explicitly, especially as he is speaking on behalf of the Committee consensus, not in a personal capacity as Quarles could do.
** The debate over whether the current real neutral rate is rising may also be a theme picked up by Powell. He will steer clear of making a call just yet on whether the neutral rate is indeed rising a bit more quickly this year than previously assumed towards its estimated longer run levels, but we suspect that is where a Committee consensus is heading.
** Chairman Powell may be pressed to be a bit more specific on how much the Fed is likely to upgrade its growth forecasts in the wake of the two-year budget deal. The median growth projection was marked up in December to 2.5% from 2.1% on the basis of the tax cuts, and many growth estimates were marked up further in January before the budget deal. A 2018 real growth median at the March meeting of 2.7% or higher would not be unreasonable.
** We are also pretty certain Chairman Powell will get questions on the current debate over the policy framework. Some Republicans in particular may press Chairman Powell on whether this talk of changing the inflation target suggests the Fed is moving away from its price stability mandate. It is an interesting political check on the Fed debate even if Powell easily sidesteps the question.
** One last thought, though we are uncertain whether it will come up in the testimonies, is that in the review of the policy framework that seems likely to get underway later this year, whether a higher inflation target, a range, an average, or price level targeting, they all to point in the same direction of a modest erring on the side of allowing for more inflation.
** We would wonder then whether the framework review itself, especially when coupled to caution against undercutting a potential lift to productivity, will translate into a willingness to tolerate a temporary overshoot of what is, after all, a symmetrical 2% target. It also points to backloaded rate hikes in 2019 and 2020 rather than 2018. In other words, a pre-emptive quickening of rate hikes on the near horizon seems pretty unlikely.