Edition #27 - 6.17.2021
FOMC Policy Meeting: Press Release & Jerome Powell Press Conference
As is usually the case, the trading days preceding an FOMC policy meeting can be best described as indecisive. Bond & equity markets trade on low volume in anticipation of the announcement & any market-changing adjustments or rhetoric. To no surprise, this week wasn’t any different and this is something that I highlighted throughout the week via my Twitter and this newsletter.
Early in yesterday’s session, I posted a thread giving my thoughts in anticipation of the FOMC press release that was scheduled for 2pm ET. Here was that post, shared around 10:30am ET:
I know today’s monetary policy meeting has the potential for important economic implications, but I’m actually not very excited/anxious about the press release. Don’t we already know the rhetoric & result? The Fed will announce that the FFR is unchanged & that they are closely monitoring economic conditions & data. They will likely mention that there is still substantial progress needed to meet their economic goals & reliance on new economic data. This will justify maintaining their current level of asset purchases, targeting $80Bn/month in Treasury securities & $40Bn/month in agency-MBS in order to “foster smooth market functioning and accommodative financial conditions”. Expect to see “transitory” at least once. Most of my attention will be on J.Powell’s press conference & question session. During this conference, we’ll get more forward-looking statements & get a gauge on how the FOMC is prioritizing economic data. I expect the JOLTS & non-farm payroll misses will be mentioned in order to justify why the inflation uptick is not causing a rush to taper. In regards to inflation comments, I’m ready for “transitory” & “base effects” to be a common theme, along with a lot of posturing that the Fed has the ability to rein in inflation if it must. As I said, I don’t expect surprises with the decision or the rhetoric.
First, let’s review the actual press release, conference highlights and Q&A, and then we can revisit my prediction. In regards to the press release & decision, the Committee voted to maintain the target rate range for the federal funds rate at 0.00-0.25%, and reaffirmed their intention to purchase at least $80Bn/month in Treasury securities and $40Bn/month in agency-MBS. The Fed justified the decision to maintain these levels of asset purchases due to their ability to “foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses”. The press release acknowledged the recent uptick in inflation in the fifth sentence, citing that the rise in inflation is “largely reflecting transitory factors”. In terms of the actual policy statement, that’s really all there was to it and it played out exactly as I had suspected.
Switching over to the press conference, I noted several highlights from Jerome Powell’s prepared comments as well as from the Q&A session that immediately followed. Here are those moments, and why I think they are important:
On the labor market: “Conditions in the labor market have continued to improve, although the pace of improvement has been uneven… The unemployment rate remained elevated in May at 5.8% and this figure understates the shortfall in employment particularly as participation in the labor market has not moved up from the low rates that have prevailed for most of the past year”.
In Edition #17 of this newsletter, I highlighted the relationship between the unemployment rate and the labor force participation rate (LFPR), noting that a decrease in the LFPR due to a discouraged labor force will naturally produce a decrease in the unemployment rate, all else being equal. I continued by giving the historical context of the LFPR and where we are relative to the pre-pandemic levels. While I didn’t explicitly state that the Federal Reserve is closely monitoring the LFPR to track the economy’s progress towards accomplishing the Fed’s goal of maximum employment, it’s great to hear the Fed reaffirm my beliefs. It’s also good to see that they are taking the unemployment data with a grain of salt, reaffirming that there is substantial progress to be made in the overall labor market.
On inflation: “Inflation has increased notably in recent months. The 12-month change in PCE prices was 3.6% in April and will likely remain elevated in coming months before moderating. Part of the increase reflects the very low readings from early in the pandemic falling out of the calculation, as well as the pass-through increases in oil prices to consumer energy prices. Beyond these effects, we’re also seeing upward pressure on prices from the rebound in spending, as the economy continues to reopen. Particularly as supply bottlenecks have limited how quickly production in some sectors can respond in the near-term. These bottleneck effects have been larger than anticipated and FOMC participants have revised up their projections for inflation notably for this year. As these transitory supply effects abate, inflation is expected to drop back towards our longer-run goal, and the median inflation projection falls from 3.4% this year to 2.1% next year and 2.2% in 2023.
In my opinion, this is the Fed’s way of aiming the inflation spotlight towards factors outside of their control, with an emphasis on the transitory behavior of the acceleration in prices. Supply shortages are certainly very real and very impactful, so the Fed is right to call attention towards these factors. I would have liked to see Powell actually identify which ones are most notable, just to have them reaffirmed, although I can confidently say that the global chip shortage, commodity pressures, and supply-chain issues would be towards the top of the list. When Powell refers to the low readings falling out of the calculation, this is what I hinted at when I mentioned “base effects”. Because the 12-month inflation data is a rolling calculation, the deflationary figures from the beginning of the pandemic are now dropping out of the monthly CPI calculation & thus adding more tailwinds to the acceleration in inflation that we’ve seen over the last few months.
More on inflation: “The process of reopening the economy is unprecedented, as was the shutdown at the onset of the pandemic. As the reopen continues, shifts in demand can be large & rapid, and bottlenecks, hiring difficulties, and other constraints could continue to limit how quickly supply can adjust, raising the possibility that inflation could turn out to be higher and more persistent than we expect. Our new framework for monetary policy emphasizes the importance of having well-anchored inflation expectations, both to foster price stability and to enhance our ability to promote our broad-based and inclusive maximum employment goal. Indicators of longer-term inflation expectations have generally reversed the declines seen earlier in the pandemic and have moved into a range that appears broadly consistent with our longer-run inflation goal of 2%. If we saw signs that the path of inflation, or longer-term inflation expectations, are moving materially & persistently beyond levels consistent with our goal, we’d be prepared to adjust the stance of monetary policy.
I thought this was the key segment of Powell’s prepared comments. It echos the sentiment from the prior comment by helping to deflect responsibility; however, citing more than just supply bottlenecks. In this quote, Powell is addressing the fact that inflationary pressures have the potential to persist based on the economic factors of the time. With that said, Powell is quick to address the fact that the Fed is prepared and capable of pumping the economic brakes by raising rates and tightening financial conditions. The key words in this quote are “materially & persistently”. The Committee is going to let inflation run its course, ensuring that we get through the transitory acceleration, and then trend back towards the longer-run target of an average inflation rate of 2%.
Q&A highlight:
Paul Kiernan, WSJ: “The Committee’s median forecast on inflation seems to assume a pretty tame outlook for the rest of the year. As you know, the 3-month annualized rate for the past 3 months was 8.4% in the CPI and I’m just wondering how much longer we can sustain those kinds of rates before you get nervous.”
Jerome Powell: “Inflation has come in above expectations for the last few months, but if you look behind the headline numbers, you’ll see that the incoming data are consistent with the view that the prices that are driving that higher inflation are from categories that are being directly affected by the recovery, from the pandemic and the reopening of the economy. For example, the experience with lumber prices is illustrative of this. The thought is that prices like that, that have moved up really quickly because of the shortages and bottlenecks and the like, they should stop going up and at some point they should actually go down. And we did see that in the case of lumber. Another example where we haven’t seen that yet is for the prices for used cars, which accounted for more than one-third of the total increase in core inflation. Used car prices are going up because sort of a perfect storm of very strong demand and limited supply. It’s going up at an amazing annual rate, but we do think that it makes sense that that would stop and in fact it would reverse over time. So we think we’ll be seeing some of that. When will we be seeing it? We’re not sure. That narrative still seems quite likely to prove correct, although as I pointed out at the last press conference, the timing of that is pretty uncertain, and so are the effects in the near-term. Over time, it seems likely that these very specific things that are driving up inflation will be temporary.”
As readers of this newsletter know, I called attention to the used car in May and just recently mentioned the lumber market in yesterday morning’s edition. I got super excited hearing Powell’s response to this question, because it essentially affirmed that the data that we’re reviewing in these newsletters is extremely relevant, considering that it is also being monitored & analyzed at the Fed to drive policy decisions. I’ve spent so much time over the last 7 years becoming a student of the Fed & the history of monetary policy, which is why the post I quoted at the beginning of this newsletter was so prescient.
I thought this Committee meeting and press conference represented an important win for the Federal Reserve. Inflation, while increasing more than they may have initially expected, has developed in a manner that tracks towards their policy goal; however, they don’t necessarily have any reason to rush to taper or adjust rates based on the fact that the labor market is still considerably weaker than the pre-pandemic conditions. The Committee was able to reassure their strength to the market, continuing to reaffirm their steadfast approach, data dependency, and willingness to act when necessary. The equity market also won from this meeting. It’s evident that the Fed will remain patient in the face of inflationary pressures, which reassures the fact that the federal funds rate will remain between 0.00-0.25% for at least the next 12 months, to allow the labor market ample time to recover & reach full employment.
We should now begin to see more decisive action in the bond & equity markets for the remainder of the week, now that the big question mark has been addressed and investors can digest the rhetoric & news. Tomorrow’s report will revert back to the normal format, reviewing the most important data & news I see throughout the session on the economy, equity market, and crypto.
Until then,
Caleb Franzen