–Powell Could Signal Consideration of Less Bond Buying Is Coming
By Steven K. Beckner
(MaceNews) – Movement away from the most aggressively expansionary monetary policy in the Federal Reserve’s history may seem glacial, but it is not imperceptible.
It seems clear, as the mid-June Federal Open Market Committee meeting approaches, that a shift in sentiment has occurred among Federal Reserve policy makers and that the FOMC will be discussing tentative steps toward less accommodation.
Despite their repeated protestations that any post-Covid inflation flare-up is sure to be “transitory,” widespread price surges accompanying the reopening of the economy have gotten Fed officials’ attention. The day’s over-the-year May CPI core rate, 3.8%, was the largest since through June 1992.
It might be a bit much to call inflation virulent, but it’s certainly evident. From cars to corn to lumber to gasoline, prices have leaped alarmingly. And Americans are becoming increasingly aware of it. Inflation expectations, which if you believe the Fed drive the inflationary process almost single handedly, no longer look so “well-anchored.”
Labor market improvements have not been as large as hoped, but have been substantial and would have been more so were it not for impediments to hiring.
There is no lack of demand for labor. Job openings are going begging because of generous unemployment benefits and other issues. There is more of a labor supply problem, which does not seem amenable to monetary accommodation.
Because of these developments on both sides of the Fed’s “dual mandate,” we are now in the early stages of preparation for an eventual firming of monetary policy, which will initially take the shape of reductions in the pace of Fed asset purchases.
Until fairly recently, the Fed’s nearly uniform party line was that the economy remained “far from” meeting its employment and inflation objectives and, hence, the Fed should be “patient” about lessening monetary stimulus.
But over the past few weeks Fed rhetoric has unmistakably changed.
So, at its June 15-16 meeting, the FOMC seems highly likely to engage in more serious discussions of when it might be appropriate to start scaling back its asset purchases from the current $120 billion per month.
The FOMC’s vague standard for “tapering” bond buying, reiterated April 28, is achieving “substantial further progress … toward the Committee’s maximum employment and price stability goals.” Raising the federal funds rate from the zero to 25 basis point target range is on a much longer trajectory.
In their March Summary of Economic Projections, FOMC participants, on average, anticipated no rate hike until 2024. We’ll get a new “dot plot” on June 16.
“Liftoff” will depend not just on achieving “maximum,” “broad and inclusive” employment but on inflation exceeding 2% “for some time.” We will probably see the same language on asset purchases and the funds rate in the June 16 policy statement.
However, step by incremental step, Fed thinking has begun to change, and depending on the tone of economic and financial data, we could see even blunter signals of impending policy firming, in the form of reduced asset purchases, in the months ahead.
Chairman Jerome Powell will have multiple communication opportunities, beginning with his June 16 post-FOMC press conference, followed by his July testimony on the Fed’s semi-annual Monetary Policy Report; his July 28 press conference; his Aug. 26 keynote address in Jackson Hole, and then his Sept. 22 press conference.
The tone of employment, inflation and other data and how financial markets react to them will determine how soon signals start coming from the top of the Fed pyramid.
Already we’re getting plenty of signals from Powell’s underlings.
At first, only non-voting Federal Reserve Bank presidents were talking about the need to discuss “tapering” before long. As early as April 30, for instance, Dallas Fed President Robert Kaplan said that “at the earliest opportunity, I think it would be appropriate for us to start talking about adjusting those purchases.” A month later, he said, “Maybe taking the foot gently off the accelerator would be the wise thing to do here.”
About the same time, Philadelphia Fed President Patrick Harker said the FOMC should start talking about tapering “sooner rather than later.” Two weeks later, he was more emphatic. “We’re planning to keep the federal funds rate low for long, but it may be time to at least think about thinking about tapering our $120 billion in monthly Treasury bond and mortgage-backed securities purchases.”
More support for starting the tapering “conversation” came from other non-voting Fed presidents on May 24. “We’re not quite there yet,” said St. Louis’s James Bullard, but “I think we will get there in the months ahead.”
Kansas City’s Esther George on May 24 cautioned that a “potential for more persistent inflation pressures” may force the Fed to respond sooner than its “forward guidance” has been suggesting. She said “policymakers will be well served to take a flexible approach to monetary policy decisions.”
“The structure of the economy changes over time, and it will be important to adapt to new circumstances rather than adhere to a rigid formulation of policy reactions,” she elaborated. “With a tremendous amount of fiscal stimulus flowing through the economy, the landscape could unfold quite differently than the one that shaped the thinking around the revised monetary policy framework.”
“That suggests remaining nimble and attentive to these dynamics will be important as we seek to achieve our policy objectives in the context of sustainable economic growth and the well-being of the American public,” George added.
Until recently, though, FOMC voters refrained from such ruminations, preferring to stick with the doctrine of open-ended “patience.” It was almost as if non-voters had been granted leeway to talk about the need to start thinking about tapering, while voters were kept on a shorter leash.
San Francisco Fed President Mary Daly explicitly deferred to Powell. “I don’t want to front-run the committee discussions by coming down on any particular thing because we’re not in a place where that’s been decided. You would hear that first from the chair and he has signaled that we’re not ready to start talking about talking about these types of things.”
But then things changed rather suddenly. As inflation fears blossomed, we got notable, back-to-back comments from two Fed leaders in late May.
First came Fed Vice Chairman Richard Clarida’s remark that “there will come a time in upcoming meetings where we’ll be at the point where we can begin to discuss scaling back the pace of asset purchases.”
The next day, Clarida was echoed by Vice Chairman for Supervision Randal Quarles:
“If my expectations about economic growth, employment, and inflation over the coming months are borne out, however, and especially if they come in stronger than I expect, then … it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings.”
Talking about tapering “at upcoming meetings” wasn’t entirely new. Minutes of the April 27-28 FOMC meeting disclosed that “a number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of
asset purchases.”
The difference now was that it was not just “a number of participants;” it was two top Board members recommending tapering be discussed “at upcoming meetings.”
Admittedly, it’s still kind of vague to say it might be appropriate to talk about tapering at some indefinite “upcoming meeting,” but it’s less nebulous than what was being said before.
That formulation could be interpreted as implying discussion of tapering will begin in one of the next few meetings and that an actual tapering signal may come at one of this year’s remaining meetings – assuming continued “rapid progress.”
Quarles had more to say than Clarida. “In particular, we may need additional public communications about the conditions that constitute substantial further progress since December toward our broad and inclusive definition of maximum employment…”
“I think I said it would soon be time to start talking about what constitutes ‘substantial further progress,’” he said. “So that would suggest it would be premature for me to put down some markers yet.”
In meeting the “substantial further progress” standard, Quarles distinguished between the “maximum employment” and average 2% inflation objectives.
On one hand, he said “obviously there’s more to go. We’re still significantly short” of achieving “maximum employment.” Whether you look at the 6.1% unemployment rate or the large number of underemployed people, he said, “By any of those measures, we’re far enough away from whenever we want to lay down markers … . We have plenty of time.”
However, Quarles said inflation has risen enough for the FOMC to think about starting to consider reducing asset purchases. “I do think that, as we’ve indicated, one (tapering) will happen before the other (liftoff) and that of the thresholds that we set down, I think what we’re seeing currently is sufficient inflation to satisfy the inflation condition for the asset purchases (tapering).”
Let’s not be too quick to conclude the monetary worm has turned. Even though sentiments have started to shift, there was still not a strong or united view that policy is too loose ahead of the June meeting. There may still be a fairly long, twisting road between starting to talk about tapering and ultimate action. Even then we’re talking about only moderate and incremental tightening – if tightening is even the word.
Not all voters are talking like Clarida and Quarles.
Certainly not Governor Lael Brainard, who on June 1 emphasized the need to keep monetary laxity indefinitely in place.
“Remaining steady in our outcomes-based approach during the transitory reopening surge will help ensure the economic momentum that will be needed as current tailwinds shift to headwinds is not curtailed by a premature tightening of financial conditions,” she said.
“The best way to achieve and sustain our maximum-employment and average-inflation goals is by remaining steady and clear in our approach while also being attentive to changing conditions,” added Brainard.
Brainard, often mentioned as a possible successor to Powell, conceded a need to be “attentive to the risks on both sides of this expected path.”
However, she was quick to add “it is also important to be attentive to the risks of pulling back too soon.
Voting Chicago Fed President Charles Evans also sounded dovish in a May 25 outing. “We need to watch all of the data very closely. The challenge will be to cut through the effects of temporary supply pressures and post-pandemic price re-normalization to get a clearer picture of underlying inflation dynamics.”
“This won’t be an easy task,” Evans continued. “But it is important to emphasize that the recent increase in inflation does not appear to be the precursor of a persistent movement to undesirably high levels of inflation.”
Evans said he has “not seen anything yet to persuade me to change my full support of our accommodative stance for monetary policy or our forward guidance about the path for policy.”
New York Fed President and FOMC Vice Chairman John Williams was more equivocal on June 3. “We’re still quite a ways off from maintaining the substantial further progress we’re really looking for in terms of adjustments to our asset purchase program.”
At the same time, he said, “We have to be thinking ahead, planning ahead, so I do think it makes sense for us to be thinking through the various options we may have in the future.”
Williams wasn’t necessarily contradicting Clarida and Quarles, both of whom would probably agree that actual adjustments to asset purchases are “still quite a ways off.”
But Williams’ comments do put those of Clarida and Quarles in perspective. “Talking about talking about” tapering can begin soon without actual tapering coming soon.
For all this evolving rhetoric, most officials still betray no sense of urgency. Even Clarida and Quarles were not really that gung ho for leaving accommodation behind. Neither displayed any rush to taper, much less raise rates.
Notwithstanding his suggestion that tapering needed to be considered “at upcoming meetings,” Clarida predicted inflationary pressures “will prove to be largely transitory.” And he said “it’s going to take some time to get a clearer sense of how supply and demand will balance.”
Quarles didn’t sound any more eager. While rising inflation and inflation expectations “will prove sufficient to satisfy the standard for inflation in the guidance around asset purchases later this year, improvement in the labor market has been slower than I would have liked,” he said.
Noting “the unemployment rate has decreased only 0.6 percentage point to 6.1%, and the labor force participation rate is still nearly the same as it was at the time of the December meeting,” Quarles said, “We need to remain patient in the face of what seem to be transitory shocks to prices and wages so long as inflation expectations continue to fluctuate around levels that are consistent with our longer-run inflation goal.”
Even inflation is not that worrisome in Quarles’ view.
“I expect that a significant portion of that recent boost to inflation will be transitory, and that it will not interfere with the rapid growth driving progress toward the Fed’s maximum-employment goal,” he said. “I expect inflation to begin subsiding at some point over the next several months and to be running close to 2% again at some point during 2022. Market-implied inflation expectations have risen only to the levels that prevailed in the early 2010s.”
Fed Governor Christopher Waller has also taken a go-slow approach, saying he wanted to see more evidence of labor market improvement and persistent price pressures. “Now is the time we need to be patient, steely-eyed central bankers, and not be head-faked by temporary data surprises,” he said.
The actual timing of tapering is going to depend on how the data unfold. By their lights, FOMC members do not yet have enough to justify an actual tightening in the near-term, but enough employment and inflation indicators have accumulated to force them to start considering a modest firming at some point in the not-too-distant future.
Please replace the graf beginning “Most glaring” with the following:
Most glaring is the upsurge in inflation. The Consumer Price Index rose 5% year-over-year in May (3.8% excluding food and energy). The price index for personal consumption expenditures (PCE), the Fed’s preferred inflation gauge, rose 3.6% from a year earlier (3.1%) core.
Housing prices are setting records in a reminder of the bubble that preceded the 2008 subprime mortgage crisis.
We’re also seeing some wage pressures. Average hourly earnings were up 2% year-over-year in May, much faster in some areas. The Fed’s Beige Book survey conducted for the upcoming meeting found “wage growth was moderate” overall, but revealed that “a growing number of firms offered signing bonuses and increased starting wages to attract and retain workers.”
Inflation expectations, on which the Fed pins such high hopes, have risen. At their peak, 10-year TIPS breakevens have risen nearly 60 basis points since the start of the year and 135 basis points from a year ago.
Survey measures of inflation expectations, which not long ago were deemed too tranquil by some Fed officials, have risen even more. One-year inflation expectations, as measured by the University of Michigan’s closely watched index, soared to 4.6% last month.
Rising inflation is a necessary, but not sufficient condition for considering tapering. Most policymakers also wanted to see further improvement in the labor market following the disappointing April employment report. The Labor Department’s May report was not spectacular but arguably good enough to fit the bill.
Last month’s 559,000 gain in non-farm payrolls was not as strong as expected, but was more than double the revised April increase. The unemployment rate dipped three tenths to 5.8%.
Granted, labor force participation slipped to 61.6%, and granted there are still 7 million people unemployed relative to pre-pandemic levels. But Fed officials are well aware payroll gains could have been larger were it not for constraints on hiring.
Job openings have surged, but employers are having a hard time filling them, because many people are reluctant to return to the workforce after more than a year sitting at home, partially because of generous unemployment benefits.
The Fed knows from its own Beige Book survey, other anecdotal evidence and the Labor Department’s JOLTS survey, that the job market is suffering from a lack of supply, not of demand. There were a record 8.1 million job openings in May, but employers are struggling to lure unemployed workers into those positions.
As the Beige Book said, “It remained difficult for many firms to hire new workers, especially low-wage hourly workers, truck drivers, and skilled tradespeople. The lack of job candidates prevented some firms from increasing output and, less commonly, led some businesses to reduce their hours of operation.”
These developments occurred as the economy grew at “a somewhat faster rate than the prior reporting period,” according to the Fed survey.
If you don’t believe it job openings are going begging, just drive around and count all the “help wanted” and “now hiring” signs.
Labor shortages – or unwillingness to work if you prefer – presents the FOMC with a dilemma. Not only do they make labor market slack appear larger than it really is, they could fuel wage pressures, squeeze profit margins and in turn lead to price pressures.
It’s hard to see how monetary policy can remedy a labor demand/supply mismatch.
Obviously policymakers want to see further labor market improvement. But arguably there has been enough, together with Quarles’ “sufficient” inflation, to at least talk about scaling back asset purchases.
That an upsurge in prices was anticipated does not make it any less impactful. And, while Fed officials continue to insist that the inflation burst is transitory, many of them have been hedging their bets. Although the mainstream consensus continues to be that recent price pressures are “transitory,” officials have increasingly conceded there are upside risks they must be aware of and be prepared to address.
For example, Clarida has said, “The Fed needs to be attuned and attentive to incoming data on inflation to ensure it is transitory. If data threaten to put inflation expectations higher, the Fed would act.”
Voting Atlanta Fed chief Raphael Bostic, after citing one-off factors that have driven up prices, said, “If those things all play out to be temporary, then any increase in inflation we see now should fall back down to more normal levels, and we shouldn’t need to respond so aggressively with policy.”
But Bostic added, “I’m paid to be nervous. So I’m going to remain vigilant and make sure that I understand exactly where the economy seems to be headed, given all these economic transitions … if it seems like the economy is moving toward overheating I will make the case that we might need to adjust policy.”
Then there was Waller: “While I fully expect the price pressure associated with these factors to ease and for some of the large increases in prices to reverse, it may take a while to do so. Shortages give producers pricing power that they will be reluctant to let go of right away. Wage increases for new workers may cause firms to raise wages for existing workers in order to keep them. Consequently, there may be knock-on effects from the current wage increases. The pandemic has also caused firms to restructure their supply chains, and, as a result, bottlenecks may last longer than currently anticipated as these supply chains are rebuilt. There are also asymmetric price effects from cost shocks – prices go up very quickly but often tend to come down more slowly, as consumers slowly learn that the bottlenecks have gone away.”
Waller said he and his colleagues “need to see if the unusually high price pressures … will persist in the months ahead.”
Even Brainard vowed to “carefully monitor inflation and indicators of inflation expectations for any signs that longer-term inflation expectations are evolving in unwelcome ways. Should inflation move materially and persistently above 2%, we have the tools and experience to gently guide inflation back down to target, and no one should doubt our commitment to do so.”
Needless to say, comments about discussing tapering “at upcoming meetings” doesn’t give a precise sense of timing or, for that matter what constitutes “substantial further progress.” We’ll have to wait and see what Powell says on June 16th and beyond.
After putting in place the easiest monetary policy in its history, the Fed has told us any change in that policy would be “outcome-based,” not calendar-based. Nevertheless, various officials have given general time frames for considering tapering. Waller talked in May about needing “several months before we get a clear picture of whether we have made substantial progress towards our dual mandate goals.”
Bostic said it will be hard to get a clear picture of inflation trends until “at least September.”
Evans was even vaguer. “I think it’s going to take quite some time for us to actually see it (progress toward dual mandate goals) in the data, assess it. I can’t give you a time frame.”
In short, tapering is getting closer, but that doesn’t mean it’s close. And even after the first actual step is taken monetary policy will remain quite accommodative, as officials have repeatedly emphasized.
As time goes on, we’re sure to hear more. By the fall, the FOMC could start considering tapering in earnest and by year’s end, it could give advance warning of some moderate tapering next year.
But communication challenges loom large. The Fed is in a predicament – partially of its own making. With the economy recovering at a rapid pace, the Fed must make monetary policy less aggressively expansionary at some point. When that time eventually comes, Powell et al have repeatedly promised to give plenty of advance notice and send very clear signals. But that will be tricky.
The Fed’s own rhetoric, coupled with its much vaunted new policy “framework,” will make a policy shift difficult. Having so fulsomely welcomed higher inflation and inflation expectations, and having promised to keep policy ultra-accommodative to maximize job growth, it’s not easy now for Fed officials to moderate their rhetoric and to set the stage for an eventual, necessary firming of policy.
In particular, how and when will it be determined that the economy has achieved “maximum” employment that is “broad and inclusive?”
Further complicating the task is a whiff of “stagflation.” Wage-price pressures have picked up, as have inflation expectations. At the same time, improvement in the labor market has moderated, though for partly for reasons beyond the central bank’s control.
How long will the Fed wait to determine if higher inflation is really “transitory?”
Any adverse labor market developments that coincide with higher inflation could give the FOMC a rationale for delaying the inevitable tightening, in keeping with its own framework promises. But there are dangers in waiting too long. Not only could inflation get embedded in the yield curve, it could get entrenched in consumer, labor and business behavior. Once that happens, history shows reversing it can be painful.
Powell and other Fed officials constantly remind us that for a quarter of a century inflation has been modest, indeed below-target, and have attributed this phenomenon in large part to low inflation expectations. Thus, they say, previous flare-ups of inflation have always proved transitory. They’re counting on a continuation of that pattern.
This rosy record is repeated in almost every Fed speech, as if uttering that mantra will ward off inflation. “Preventive incantation” is what John Kenneth Galbraith used to call it.
What they neglect to mention is that never before has the United States experienced such a combination of monetary laxity and fiscal recklessness.
For most of the last three decades, under both Republican and Democratic administrations, whenever the U.S. government strayed from sane fiscal policies conscious, if imperfect. efforts were made to get back toward greater balance and toward lower debt-to-GDP ratios.
Likewise with monetary policy, when the Fed veered into zero interest rates and quantitative easing after the financial crisis the emphasis was on the need for “normalization.” For most of that time too, the U.S. followed an explicit “strong dollar” policy.
Now, the U.S. has thrown caution to the wind fiscally and monetarily. Is it reasonable to expect inflation expectations to remain “well anchored?”
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Contact this reporter: steve@macenews.com.
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