Notes on the FOMC Press Conference 21–9–22
With a direct tone, Chair Powell frequently reiterated that the FOMC will do whatever it takes to regain price stability. This means that, for the moment, our central bank is operating off of a single mandate. In order to regain price stability, the committee see’s it necessary to have a real Federal Funds Rate that is positive. This will require an FFR target range around 4.4% by the end of the year increasing to about 4.6% next year. Given that, at the moment, we’re in the 3 to 3.25% range, we can absolutely expect the FOMC to continue to raise rates in order to quell inflation.
Extrapolating these facts into analysis, I believe the FOMC must slow consumption going into the holiday season in order to prevent inflation from ticking higher and causing more economic damage over the longer term. True, this is an outlook that Chair Powell is playing the grinch, and I’ll forgive you for surmising that, at first glance. A more nuanced understanding reveals, to paraphrase the Chair, if we don’t take our medicine this instant, inflation expectations will become intrenched, and that will lead to a much longer and more economically damaging path back to price stability.
Why is the threat of intrenched inflation expectations eliciting fear from the FOMC? The wage price spiral. Should people, particularly those on the short end of the income stick, begin to develop heuristics of persistent inflation, they will naturally demand higher wages which will drive up costs until we spiral.
How is the FOMC approaching a prolonged period of consistent rate raises while working to prevent overshooting and crashing the economy? Frankly, nothing said today makes it appear they’ve ruled out accidently raising rates too high. Rather, the committee is of the understanding that continued inflation above target is more damaging than higher unemployment or a recession, so is choosing to focus on price stability overall. This, the chair claims, will allow the US economy to emerge from the current bout of inflation, into another decade long economic expansion. Because the previous expansions have done well to increase the lot of society’s most vulnerable, short-term slowing of growth and a potential fall in employment figures are deemed justified by the committee.
That isn’t to say members aren’t closely watching the data. One of my big take aways was when Chair Powell stated that a key datapoint being used to measure the strength of the economy is the ratio of job vacancies to unemployed people, which sits at almost 2-to-1. I believe the FOMC will like to see this fraction come closer to equilibrium, as that will show a more balanced labor market. Moreover, this is a metric that is timelier than CPI so offers a better perspective.
The number of people quitting their jobs each week was also mentioned as a key datapoint and that checks out. If the economy slows and people lose the ability to easily switch jobs, wages will become stickier which will impact wage driven inflation. This will also impact demand because inflation will, temporarily, continue to raise eroding purchasing power. But, if workers can’t quit because there’s nowhere to go, they can’t repair the erosion, so will be forced to consume less.
A final figure to consider is the overall unemployment level, which the FOMC has projected could rise to 4.4% next year vs 3.7% today. However, I see the Fed operating from a single mandate for the near future, so take this statistic’s relevance with a grain of salt. Also, the Natural Rate of Unemployment isn’t nailed down like the 2% rate of inflation. In the past, we’ve seen periods where 5% and 6% unemployment rates were considered expectable, so not to drone on, but this simply isn’t a key metric, save a major spike.
In terms of the slowing housing market, the FOMC is appears to be actively pursuing a course of price correction in order to rebalance supply and demand. Running with this, we can see that rising home prices, due to a supply/demand imbalance, causes inflation two ways. First, the wealth effect causes people to spend more because they simply feel wealthier. Second, the increased value may be used to either purchase a ‘better’ home, or to draw equity out of the property for spending on consumption. Both drive inflation higher and the former exasperates the tight housing market. Finally on housing, Chair Powell stated incredibly clearly that the FOMC is not concerned with how Mortgage Backed Securities are performing as the Fed draws down its balance sheet.
Looking forward, I feel confident in an expectation of at least one more 75bps rise to the Federal Funds Rate, and an added 50bps after that. It appears Chair Powell is doing everything he can to walk the line between firm guidance that there will be no Fed pivot until inflation is controlled, whilst preventing too heavy or inconsistent a hand leading to panic in markets. As the Chair briefly mentioned, and anyone can observe, credit markets are still functioning efficiently and even with raising rates, I cannot see that materially changing. So, for the next year or two, we’ll have slow growth or may see a mild recession. Best case, inflation is controlled by next summer and we see the FFR remain high into next fall to make sure the embers are stomped out, and prices will be stable for good. I still cannot see rates rising above 5% and am beginning to believe they’ll settle closer to 4.5% and sit there for six months but, it’s truthfully anyone’s guess.
To sum it all up, rate rises will continue through next year and the Christmas consumption season will pass within the backdrop higher prices and a tighter labor market. The Fed isn’t concerned with a modest uptick in unemployment because the alternative is (correctly) viewed as being much worse. The Chair said that he is looking for a correction in the housing market and believes this will help restore supply and demand. Putting this all into a single sentence: Rate raises will continue until inflation is stopped and will only be reversed after the FOMC feels it won’t come back.
