Modern-hawkish, not Volcker-hawkish.
By Wolf Richter for WOLF STREET.
Fed Chair Jerome Powell lobbed some choice nuggets in his press conference on June 16 after the FOMC meeting, some of which I dragged into the foreground when I discussed the FOMC’s decisions that then jostled the markets. The others I left sitting there, stewing in their juices, because they weren’t directly relevant to the FOMC’s decisions, including what came at the end of the press conference when he appeared to let down his hair a little. So here we go.
“We will taper” even if there is a “market reaction.”
This was in response to a question about the possibility of a Taper Tantrum, and about the Fed’s current efforts to jump through hoops to avoid it. The original Taper Tantrum was the Treasury market’s reaction in 2013 to the Fed’s suggestion that it might actually “taper” QE infinity out of existence. The 10-year yield jumped from 1.70% to 3.04% in eight months before it started actually tapering. So here is Powell:
“We will taper when we feel that the economy has achieved substantial further progress, and we will communicate very carefully in advance on that. And that’s what we’re going to do, and we will follow through on that. We’ll do what we can to avoid a market reaction. But ultimately when we achieve our macroeconomic goals, we will taper as appropriate.”
If inflation goes on longer than expected, “we would not hesitate to use our tools.”
Inflation has been red-hot in recent months. What if the Fed is way behind the curve, and inflation continues to exceed expectations and doesn’t back down?
“We don’t in anyway dismiss the chance that it [inflation] goes on longer than expected. And the risk would be over time that it does begin to affect inflation expectations. And if we see inflation expectations, or inflation, moving up in a way that is materially above what we would see as consistent with our goals and persistently so, we would not hesitate to use our tools.”
“Turns out it’s a heck of a lot easier to create demand” than supply.
We’re all learning something here, even Powell. When he was asked about raising interest rates too far and triggering another recession, given that this is what happened before, Powell said among other things:
“Turns out it’s a heck of a lot easier to create demand than it is to bring supply up to snuff.”
“That’s happening all over the world, there is no reason to think that that will last indefinitely. We’re going to watch carefully the evolving inflation, and that our understanding of what is happening is right. And in the meantime, we’re going to conduct policy appropriately.”
A higher neutral rate “would be a good thing,” and why the Fed avoids negative interest rates. Pointing at the ECB: “We don’t want to be in a place where we can’t react.”
In the Summary of Economic Projections from the FOMC meeting, the “longer run” federal funds rate was projected to be 2.5%, compared to 0.1% for 2021 and 2022. This projection would be something like a neutral rate that the Fed eventually wants to get back to. During the press conference, Powell was asked specifically about the longer-run neutral rate, or R-star (r*). Here’s what he said:
“A higher neutral rate would mean interest rates would run higher by that amount. And that would be a good thing from the standpoint of the economy because it would give the Fed more room to cut rates.
“The problem with interest rates being close to the lower bound [near 0%] is that it really cuts into our ability to react to a downturn, for example to a pandemic.
“And you can look, for example, to the European Central Bank; their policy rate was well below zero when the pandemic hit. So we don’t want to be in a place where we can’t react.
“A higher neutral rate, from that narrow standpoint, would be a good thing for us. It would give us more room, and that would result in better outcomes for the economy over time.
“You can’t estimate it [r-star] with great precision. Studying r-star is a whole industry unto itself. We would look to factors that might raise the neutral rate of interest. We try to keep up with that, and we’re all thinking about that, and the possibility of that.
“There are many stories right now that could lead to higher productivity growth and higher r-star. We don’t know which of those stories come true. I’ll give you an example: There are a lot of startups, a lot of early stage companies; will that have an effect? We don’t know. But we’ll be watching those things carefully.”
This was another confirmation of what the Fed has been saying for years: Negative interest rates are off the table even during a Pandemic. Zero is the lower bound. And higher interest rates in the good times would be “a good thing” for the Fed and the economy because, when there is a problem, the Fed has more room to cut rates. All of this added to the “hawkish” nuances – by the modern meaning of “hawkish,” not Volcker-hawkish – now emanating from the Fed.
One of the big Fed doves, St. Louis Fed President James Bullard, is making “hawkish” noises, projecting higher inflation and pulling the first rate-hike into 2022. Things are tightening up quickly here. Read… When Fed Doves Turn Hawkish, it Gets Real: Fed Dove Bullard Gets Antsy about Inflation, Pulls Rate Hike into 2022, Sees Quicker Tapering with MBS amid “Threatening Housing Bubble”
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