United States Federal Reserve Chair Jerome Powell managed to thread the needle. After unwittingly igniting several rallies in stocks and bonds with his mixed messages on the path of interest rates earlier this year, Powell this time was able to capture the nuance needed to explain the increasingly fraught path of monetary policy from here. So not only did he suggest the central bank is on the cusp of slowing the pace of rate increases — one for the doves — he also said the rate at where the Fed ultimately ends up is likely to be higher than policymakers forecast in September — one for the hawks. Not an easy message to deliver, but one that came across loud and clear.
The key challenge, of course, was in prepping financial markets for the coming slowdown in the pace of rate increases after the Federal Open Market Committee raised its target for the federal funds rate by 75 basis points for the third straight time, to a range of 3.75 percent to 4 percent. Policy makers correctly feared that such a message risked talk of a Fed “pivot”, and triggering another rally in stocks and bonds, which could have eased financial conditions, and worked against their fight to tame inflation. The swaps market is now pricing in a “terminal” fed funds rate of 5.10 percent.
The solution? Powell paired language about the looming slowdown with a warning that the fed funds rate was ultimately heading to an even higher destination than the central bank had predicted:
At some point, as I’ve said in the last two press conferences, it will become appropriate to slow the pace of increases as we approach the level of interest rates that will be sufficiently restrictive to bring inflation down to our 2% goal. There is significant uncertainty around that level of interest rates. Even so, we still have some ways to go, and incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected.
History is littered with episodes of Fed chairs sending unintended messages to the market, but Powell’s streak of mismanaged press conferences in the first half of 2022 was particularly ignominious. Every time he went before a microphone after FOMC press conferences from March to July, he waffled in the way he delivered a complex message about the economy, and bulled up traders only heard what they wanted to hear. The result is that market-based borrowing costs briefly fell and financial asset prices rose, making people feel less poor (yes, this barbaric system, in a strange way, is how monetary policy works.)
But by the time he delivered a speech at the Fed’s retreat in Jackson Hole, Wyoming in late August, Powell had clearly learned that his rhetoric —a key tool for managing prices in financial markets —needed to be sharpened. In that key address, he took few chances and delivered terse and entirely-scripted remarks that made clear that the Fed intended to keep policy tight “for some time”.
What was even more impressive was how he carried over his new-found clarity into a more challenging press conference after the September rate decision. But this week’s task was the hardest yet, because of the subtleties of the argument he had to make.
Speaking on November 2, Powell also made as clear as he ever has that he’s significantly more inclined to over-tighten monetary policy than to underdo it. That nugget was an arrow through the hearts of doves who think Powell needs to be more attentive not just to existing signs of stress in a key part of the economy — the US housing market — but also to the “long and variable lags” through which monetary policy is thought to operate. Speaking about those lags, Powell said:
You want to consider them but not take them literally. So I think it’s a very difficult place to be but I would tend to be – want to be in the middle looking carefully at what’s actually happening with the economy and trying to make good decisions from a risk management standpoint, remembering of course that if we were to overtighten we could then use our tools strongly to support the economy whereas if we don’t get inflation under control because we don’t tighten enough now we’re in a situation where inflation will become entrenched.
The end result of Powell’s press conference is something his Fed colleagues must surely see as a sign of success: yields on two-year US Treasury notes rose eight basis points on the day and the S&P 500 Index retreated about 2.5 percent, keeping financial conditions tight and probably dashing any hopes that doves may have had that a policy ‘pivot’ was imminent.
Markets are always looking forward, and will keep trying to game out the end of this tightening cycle, and they’re not crazy to do so. History shows that elevated fed funds rates rarely stay at their peak for long, especially in an environment of brewing economic stress. But for now, Powell needs markets to believe that financial conditions need to stay tight or get even tighter so that he can slay inflation and avoid a so-called hard economic landing. His performance on November 2 showed he’s learned how to get that message across.
Jonathan Levin has worked as a Bloomberg journalist in Latin America and the US, covering finance, markets and M&A. Views are personal, and do not represent the stand of this publication.
Credit: Bloomberg
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