Modern-hawk, not Volcker-hawk.
By Wolf Richter for WOLF STREET.
Fed Chairman Jerome Powell threw some choice nuggets at his June 16 press conference following the FOMC meeting, some of which I brought to the fore when I discussed the decisions of the FOMC which then shook up the markets. The others I left sitting there, simmering in their own juice, as they weren’t directly linked to the FOMC decisions, including what happened at the end of the press conference when it seemed to let go of a little hair. So let’s go.
“We will decrease” even if there is a “market reaction”.
This was in response to a question about the possibility of a Taper Tantrum and the Fed’s current efforts to jump through the hoops to avoid it. The original Taper Tantrum was the Treasury market’s reaction in 2013 to the Fed’s suggestion that it could in fact “cut” QE infinitely. The 10-year yield jumped 1.70% to 3.04% in eight months before starting to taper. So here’s Powell:
“We will decline when we feel the economy has made substantial further progress, and we will communicate very carefully in advance about this. And that’s what we’re going to do, and we will follow through on it. We will do what we can to avoid a market reaction. But at the end of the day, when we hit our macroeconomic targets, we will decrease where necessary. “
If inflation continues for longer than expected, “we will not hesitate to use our tools”.
Inflation has been skyrocketing in recent months. What if the Fed is way behind schedule and inflation continues to beat expectations and does not fall?
“We do not in any way reject the chance that he [inflation] lasts longer than expected. And the risk would be that over time this would start to affect inflation expectations. And if we see inflation expectations, or inflation, rising in a way that is significantly above what we consider consistent with our goals and persistently, we would not hesitate to use our tools. “
“It turns out that it is much easier to create demand” than supply.
We’re all learning something here, even Powell. When asked to raise interest rates too high and trigger another recession, given that this has happened before, Powell said among others:
“It turns out that it’s much easier to create demand than it is to match supply. “
“It is happening all over the world, there is no reason to think it will last indefinitely. We will carefully monitor the development of inflation and make sure that our understanding of what is going on is correct. And in the meantime, we will conduct the policy appropriately.
A higher neutral rate “would be a good thing”, and why the Fed is avoiding negative interest rates. Pointing out 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-term” federal funds rate was projected at 2.5%, compared to 0.1% for 2021 and 2022. This projection would be something like a neutral rate. that the Fed ultimately wishes to return to. During the press conference, Powell was asked specifically about the longer-term neutral rate, or R-star (r *). Here is what he said:
“A higher neutral rate would mean that interest rates would rise by the same amount. And that would be a good thing from an economic point of view because it would give the Fed more leeway to cut rates.
“The problem with interest rates close to the lower bound [near 0%] is that it really reduces our ability to respond to a downturn, say 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 perspective, would be good for us. That would give us more room, and that would translate into better results for the economy over time.
“You can’t estimate it [r-star] with great precision. Studying r-star is an industry in its own right. We would look at the factors that could increase the neutral interest rate. We try to follow it, and we all think about it, and the possibility of it happening.
“There are many stories out there right now that could lead to higher productivity growth and a bigger star. We don’t know which of these stories comes true. I’ll give you an example: there are a lot of startups, a lot of start-up companies; will this have an effect? We do not know. But we will be watching these things carefully.
This was further confirmation of what the Fed has been saying for years: Negative interest rates are not an option, even in a time of a pandemic. Zero is the lower bound. And higher interest rates at the right 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” undertones – in the modern sense of “hawkish”, not Volcker-hawkish – now emanating from the Fed.
One of the Fed’s big doves, St. Louis Fed Chairman James Bullard, is making “hawkish” noises, projecting higher inflation and pulling the first rate hike in 2022. Things are tightening fast here. Lily… When Fed Doves go hawkish, it becomes real: Fed Dove Bullard worries about inflation, pulls rate hikes through 2022, sees faster cut with MBS amid ‘looming housing bubble’
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