Talking about talking
Prologue
It’s the peak of summer in many places around the world. In Dubai, it often hits the early 40s (centigrade not Fahrenheit!) and the word “sizzling” is overused on social media. It’s frankly not something that anyone looks forward to.
On the other hand, the Fed press conference (and the documents that are released prior to that) are much-awaited segments of the calendar.
The Fed released its latest statement and the Summary of Economic Projections (SEP). Lord Powell came out of the 2-day conclave and held forth to a gaggle of reporters, virtually of course.
Anticipation is everything
Everyone and his uncle knew that the FOMC wouldn’t make any substantive steps (read ‘cutback’) in terms of its massive securities purchases of $120 billion a month. The key fed funds rate was not expected to budge from the current 0% to 0.25%. The Fed was also expected to raise growth and inflation forecasts for 2021 and to reiterate that inflation is transitory.
So, what was the fuss all about?
THIS is what the market wanted to know:
Any hints about when tapering of its $120 billion in monthly asset purchases might begin
Any movement in the dots that are part of the SEP to suggest rising inflation is pulling forward members’ rate hike projections
How the FOMC will update its inflation forecasts through 2023.
Sneak preview- the market got info on the last two points, but Powell was coy on the first. More on that below.
What goes up must come down
Powell repeated his mantra that he expects inflation to be high for a short period before falling back down, closer to 2%. The Fed also raised its inflation forecast for 2021 from 2.4% (March 2021) to 3.4% now.
Investors didn’t get any sign that the Fed might believe that inflation is more permanent. Quite the opposite. Powell repeated the claim that inflation is due to supply chain bottlenecks being larger than anticipated.
What I liked the most about his words on inflation was the rarely mentioned yet hugely important mention of secular trends. Powell admitted that the decades old deflationary factors, the structural changes such as aging population, low productivity and globalization, will stay the same post pandemic. I hope those wringing their hands and screaming “inflation” bear this in mind.
Question #1- It isn’t clear exactly, however, what transitory means — months, years? How long are higher levels of inflation to be tolerated before market participants and the Fed lose patience with inflation that undermines asset prices? The fact that the Fed has a “framework” isn’t reassuring as it remains deliberately ambiguous.
Question #2- Powell solemnly stated that forecasting is a risky business. I agree. But he said that to justify why the inflation hawks are wrong. Which makes Yours Truly ask- doesn’t that also mean that his own forecast that high inflation will soon subside should also be taken with a grain of salt?
Joining the dots
The Fed’s dot plot diagram from March showed four of 18 FOMC members expecting an interest rate rise in 2022 and seven projecting an interest rate rise by the end of 2023.
This time around the median forecast is for two rate hikes in 2023. That was unexpected.
Question- GDP growth is expected to cool down from 7% in 2021 to 3.3% in 2022 to 2.4% in 2023. Inflation is also expected to decline from 3.4% in 2021 to 2.2% in 2023. So why the heck would you raise rates in 2023?
Powell had an answer (the man has answers for everything). The rising rates in 2023 are due to inflation due to “lower unemployment and increased resource utilization”.
I think that’s bullshit. I think the Fed is planning exactly what Yellen did in December 2015 by raising rates although there was no sign of the inflation genie or the economy overheating. The truth is this- the Fed must raise rates to build a buffer so that they can cut rates and save the economy the next time a collapse is imminent. And if stock markets take a hit so be it- short term pain, long term gain etc.
Show me the jobs
We have a paradoxical situation where inflation is rising rapidly but job growth is muted.
This also presents a bit of a problem for a Fed that is trying its best to ensure maximum employment and price stability, its twin goals. It’s an issue because while rising inflation may drive a tighter monetary, lackluster jobs numbers are a big reason to keep a loose policy. The disappointing jobs numbers in April and May are a signal that the economy needs ongoing support- There were a record 9.3 million unfilled openings in April.
The situation now is almost the exact opposite of the years long trend post the GFC where unemployment was ratcheting down but inflation remained subdued despite massive QE.
The increase in payrolls appears to be constrained probably more by the lack of supply of labor than businesses’ desire to hire. Powell opined that this is happening for 4 reasons:
1. Those who could easily get back to their old jobs have already done so. The next cohort is of people who need to find a new job and that takes more time.
2. Many are still scared of catching Covid if they return to work, especially in customer-facing businesses like food service and retail. This hesitation should be nullified by the progress in vaccinations.
3. Many can’t go to work as they are grappling with childcare issues as schools aren’t open, a situation that should get better in the fall as vaccinations are widespread.
4. Employers aren’t finding enough workers because of generous unemployment compensation. But 25 states end the extra $300 weekly payment early. These 25 states account for about a quarter of all the unemployed workers and ending their extra jobless benefits could boost employment by roughly 2 million in the next few months. Another jump should follow in September and October after the remaining states follow suit.
Taking away the Punchbowl
The one phrase that Powell clearly hates to mention is “talking about talking” about tapering.
The key criterion for looser Fed policy is whether the Fed sees “substantial further progress” toward what they deem as maximum employment. In the face of rising inflation, the timing of any tapering looks tricky since the recovery in the labor market still looks dodgy.
As employment rises, the Fed might start talking about reducing its massive securities purchases. Given the legendary “taper tantrum” in 2013, the Fed will want to disclose how, when, and how fast it plans to slow its buybacks.
The Fed’s traditional Jackson Hole confab in late August may talk about tapering. This will probably come out officially at the September FOMC (the next update from the Le Fed since they did promise to give us lots of warning and if we can’t believe the Fed who will we believe??) with a tapering announcement at the December FOMC and actual tapering in Q1 2022.
All Powell would say despite repeated questions was that the tapering will be orderly, methodical and transparent. He refused to commit on how far in advance of tapering will the notice be issued. The man deserves an A for grit and an A + for not saying anything (even inadvertently) that would have upset markets.
Question- Why does the Fed continue to buy $40 billion in MBSs every month when the housing market, by all accounts, is over heated and doesn’t need that support?
How to make money
Repeated assurances from the Fed that rising prices are transitory and falling U.S. Treasury yields have helped ease some concerns over inflation and supported U.S. stocks in recent weeks.
Hence markets shrugged off a scorching hot consumer inflation reading for May. The 5% jump is probably a temporary reaction to the reopening economy, supply chain disruptions and pent-up demand.
It seems the only thing that thing Mr. Market cares about right now is employment because that’s the only thing that can make the Fed sit up and take notice since it believes inflation will be fleeting. So, watch out if the jobs numbers (Non-Farm Payrolls) misses expectations by a mile- stocks could soar or slump and the latter presents buying opportunities. Confucius say “keep a watchlist”.