Jay Powell is pushing the economy to recession. He has made it clear that inflation is his number 1 priority and yesterday he stated that “inflation has not really come down”. Today, the market is still digesting the news and strategists are revising their forecasts.
The fact that Powell publicly stated he believes the Fed hasn’t made progress on inflation is huge. He is telegraphing that , despite the 300bps of Fed Funds hikes and despite short-term Treasury yields at 15 year highs, he believes tightening financial conditions have yet to make a dent.
“Our expectation has been we would begin to see inflation come down, largely because of supply side healing. We haven’t. We have seen some supply side healing but inflation has not really come down.” — Jay Powell, Fed Chair
So is Powell right? Or is he driving full-speed towards a cliff while looking at the flat terrain through the rear-view mirror?
Remember, 400 PhD economists at the US Federal Reserve didn’t think to remove monetary accelerant last year while asset prices skyrocketed and unemployment approached record-low levels. So I wouldn’t rely on their forecasts too heavily.
Many firmly disagree with Powell’s assessment:
“The monetary policy has lags that are long and variable. But we’ve been tightening now for a while. And the impact of these tightenings is going to cumulate into a recession. … I do think the Fed should be slowing down on these rate hikes.” — DoubleLine Capital CEO, Jeff Gundlach
Powell may be making two mistakes:
First, monetary policy transmission to the real economy takes an unpredictable amount of time, sometimes up to 18 months. So it is arguably too soon to judge whether or not the rate hikes to date are sufficient. Interest rate policy is like swinging blindly at a piñata. Maybe you hit it on the first swing, maybe it takes 50 swings. Either way, you hope to avoid bashing too many observers while you do it. And you don’t really know how successful you are until it’s all over.
Second, the Fed’s read on inflation may be wrong. Some argue that data is already showing inflation is starting to ease in some pockets. The CRB Index – which tracks the performance of 19 commodities – is down 14% from its June 2022 high. It is reasonable to expect cheaper energy and base metals prices to filter through to finished goods over time.
Or perhaps he’s not making a mistake at all. Maybe he’s simply not willing to take his foot off the brake until it’s obvious to all that the inflation is under control. Doing so too soon risks a reversal of any progress made so far – this is what happened during the 1970s. Many economists at the time feared that if they pushed too far they might trigger another Great Depression. (Note: that many policy makers at that time had actually lived through the Depression and saw the damage central bank policy can inflict, so they were sensitive to this possibility.)
Today, economists look to Fed Chair Paul Volcker’s aggressive tightening during the early 1980s for inspiration. Volcker is credited with finally breaking the back of inflation that had plagued the US during the 1970s, setting the stage for a disinflationary tailwind that benefited all asset prices for decades.
“I believe 75 is the new 25 until something breaks, and nothing has broken yet. The Fed is not anywhere close to a pause or a pivot. They are laser-focused on breaking inflation. A key question is what else might they break.” — Bill Zox, portfolio manager at Brandywine Global
Just like you don’t stop taking a course of antibiotics just because symptoms eased, he won’t stop tightening monetary conditions just because there are hints that inflation might be slowing down. Instead, he is purposely driving the economy off a cliff to ensure inflation is killed for good.
Will it be a big cliff or a little cliff? Who knows. Powell is telling us what he’s doing and is preparing us for recession. Now is probably not the time to fight the Fed.
“No one knows whether this process will lead to a recession or if so how significant that recession would be. That’s going to depend on how quickly wage and price inflation pressures come down, whether expectations remain anchored and also if we get more labor supply.” — Jay Powell, Fed Chair