When might the US Federal Reserve start pulling back on monetary stimulus? Investors had been hoping that today's presentation by Fed Chair Jerome Powell to the Kansas City Fed's virtual Jackson Hole symposium would provide some clues. And the takeaway is....the Fed is thinking about it, but is not yet ready to pull the trigger.
The title of the symposium was "Macroeconomic policy in an uneven economy", and Powell chose to stress that "uneven" theme throughout his remarks. After noting that the COVID recession of 2020 was the "briefest yet deepest on record", Powell talked up the recovery in output and employment that has ensued. Output recovered to its previous peak in just four quarters, but while goods-producing sectors, particularly durables, have flourished, services have not:
Even today, with overall gross domestic product and consumption spending more than fully recovered, services spending remains about 7 percent below trend. Total employment is now 6 million below its February 2020 level, and 5 million of that shortfall is in the still-depressed service sector.
Powell stated that "maximum employment" is one of the Fed's two principal goals. Job creation has been strong:
The pace of total hiring is faster than at any time in the recorded data before the pandemic. The levels of job openings and quits are at record highs, and employers report that they cannot fill jobs fast enough to meet returning demand.
....but the picture is not uniformly positive:
The unemployment rate has declined to 5.4 percent, a post-pandemic low, but is still much too high, and the reported rate understates the amount of labor market slack. Long-term unemployment remains elevated, and the recovery in labor force participation has lagged well behind the rest of the labor market, as it has in past recoveries.
On balance, it appears that the Fed wants to see more sustained progress towards its maximum employment goal before it looks to start tightening policy. As for its other principal goal -- achieving an inflation rate at or just above the 2 percent target -- Powell had this to say:
Over the 12 months through July, measures of headline and core personal consumption expenditures inflation have run at 4.2 percent and 3.6 percent, respectively—well above our 2 percent longer-run objective. Businesses and consumers widely report upward pressure on prices and wages. Inflation at these levels is, of course, a cause for concern. But that concern is tempered by a number of factors that suggest that these elevated readings are likely to prove temporary.
Powell then adumbrated some of the factors that have convinced the Fed that price pressures are temporary. These include the absence of broad-based inflationary pressures, the persistence of well-anchored inflation expectations, relatively tame wage growth and, perhaps surprisingly "the prevalence of global disinflationary forces over the past quarter century".
It seems odd that the Fed would place any faith in the continuation of historical price trends, in the context of an economy that has been roiled by a once-in-a-century pandemic and kept afloat by unprecedented stimulus measures. The core PCE deflator referred to by Powell became a Fed favourite during the Greenspan era, as the Maestro shopped around for a price index that would support his view that no monetary tightening was needed. The July increase of 3.6 percent is the biggest in three decades -- longer than Powell's "quarter century" reference period -- and represents a remarkably sharp increase from just a few months ago. The corresponding figure for March was 2.0 percent.
So, finally, to the policy implications, first as regards quantitative easing:
We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals.....My view is that the "substantial further progress" test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC's recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks.
The wording here makes it unlikely that there will be any "taper" at the September FOMC meeting, but the market's expectations for things to change in November or December look well-founded. As for the much more significant step of actual rate hikes, that seems much further into the future:
The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test. We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time. We have much ground to cover to reach maximum employment, and time will tell whether we have reached 2 percent inflation on a sustainable basis.
Markets have taken Powell's response in stride, with no sign of a "taper tantrum". If the Fed really is for the moment more focused on employment than inflation, then the August non-farm payrolls report, due a week from today, will be even more important than normal in shaping expectations.
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