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Monday, September 5, 2022

Federal Reserve Chair Powell Gives Business Leaders at Jackson Hole A Call-To-Action: 'The Fed Won't Lower Prices Until You Do'

If you're wondering what sent the markets into free-fall, it was Federal Reserve Chair Jerome H. Powell's speech. He essentially told a group of business leaders at Jackson Hole that he was going to raise prices on debt until they (business leaders) lowered prices for the average consumer and/or increased wages for the average worker. It didn't go over well.

If you’re ever going to hear about what's really going on in the economy, it’s when business leaders meet at Jackson Hole. So, I like to review any speech coming from the Fed at these conferences. It did NOT disappoint. In fact, I commend Powell for what he said, because he had a choice. He could have drawn a line in the sand, as he's doing, or he could have raised rates slowly and pushed the cliff the economy is inevitably going to fall off of into the next Fed Chair's realm. After years of making up new tools to pump 'liquidity' into the market, Powell is now pumping the brakes and there's no telling where it will lead to. Still, you have to give the guy credit for doing what few of his predecessors have had the balls (or ovaries in the case of Yellen) to do: take a stand.

So what did he say?

First, we get the following opening:

At past Jackson Hole conferences, I have discussed broad topics such as the ever-changing structure of the economy and the challenges of conducting monetary policy under high uncertainty. Today, my remarks will be shorter, my focus narrower, and my message more direct.

There’s no anecdote — he just gets straight to it. You know we’re about to hear something that moves markets, which is exactly what his speech did.

But first he lays the groundwork by saying that he understands what business leaders are saying: lower rates are hurting growth. Since the business community gets paid based on growth objectives, this is their primary concern. To this complaint Powell has the following response:

While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.

Far greater pain for who? Banks. Banks get paid back with less dollars during periods of inflation. Rampant inflation can shut a bank down. So, Powell tells business leaders that he's going to continue to raise rates (bank lending fees) to make up for the increase in inflation, but for how long? To this question Powell responds with a conditional rather than a date:

While the lower inflation readings for July are welcome, a single month's improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.

In other words, 'the Fed will continue to raise rates until inflation declines'. But what exactly does this mean? It means:

We [The Federal Reserve] are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2 percent.

2% inflation is what the Fed needs to see. Until then, it will continue to raise rates. And, what exactly does that entail? Are we talking yet another 75 bps (3 quarter point hikes in one) like last time? The answer is 'Yes'. In Powell’s words:

July's increase in the target range was the second 75 basis point increase in as many meetings, and I said then that another unusually large increase could be appropriate at our next meeting.

So Powell is telling these folks exactly what’s going to happen. He’s telling them to brace for much higher rates because there are more “unusually large” increases to come.

Okay, it’s clear the Fed is focused on inflation, but what’s scaring the market is that it’s using inflation numbers (CPI) as a way to direct future actions. Why is this bad? There’s a debate as to whether or not the Fed can actually control inflation. Powell does a good job of explaining the argument here:

It is true that the current high inflation is a global phenomenon, and that many economies around the world face inflation as high or higher than seen here in the United States. It is also true, in my view, that the current high inflation in the United States is the product of strong demand and constrained supply, and that the Fed's tools work principally on aggregate demand. None of this diminishes the Federal Reserve's responsibility to carry out our assigned task of achieving price stability. There is clearly a job to do in moderating demand to better align with supply. We are committed to doing that job.

So, even if the Fed doesn’t have the tool-set required to lower inflation, they are going to continue to raise rates until something gives. This is starting to feel like a game of chicken between the banks and corporations. Of course, banks are in a better position because they get paid either way.

Powell goes on to say:

Our monetary policy deliberations and decisions build on what we have learned about inflation dynamics both from the high and volatile inflation of the 1970s and 1980s, and from the low and stable inflation of the past quarter-century. In particular, we are drawing on three important lessons.

So, what is the first lesson:

The first lesson is that central banks can and should take responsibility for delivering low and stable inflation.

The second lesson:

The second lesson is that the public's expectations about future inflation can play an important role in setting the path of inflation over time.

The third lesson:

...we must keep at it until the job is done. History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting.

He goes on to say:

The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched.

Yikes. Again, no wonder the market took a dive. Powell is essentially saying:

  1. I know our tools can’t fix the problem, but we’re going to raise rates anyway.
  2. The best way to decrease inflation is to change public opinion.
  3.  To that end, we must work together. If we can get the public to “believe” inflation is down, we’re half way home.

This sounds like a good plan, but it's problematic for business leaders. Powell is telling them that workers need higher wages, which translates into slower growth for some industries. He’s also telling them that the alternative is a prolonged period of slow to no growth:

The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year.

In no uncertain terms, Powell is telling the business community that they need to raise wages/lower prices and they need to do so quickly in order to stave off what could become a long, prolonged recession. He’s also telling them that the Fed is willing to take full blame for what ensues, but it will not let up and will continue to raise rates until inflation falls back into line. 

Pandora Is Out

Powell is giving the business community a call to action: lower prices and/or increase wages. Both result in lower earnings, which is why the market is falling. The question is not: 'Are we in pain?' it's 'How long will we be in pain?'

Let’s see if the business community steps up or calls his bluff. Either way, Powell's done his job. He sounded the alarm. He had many options, but he’s choosing to draw a line in the sand. I commend him for what he’s doing, but it will be a miracle if his call-to-action actually works.

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