The guest commentary below was written last night by Mike O'Rourke of JonesTrading.
Today was one of the most surreal days in the history of monetary policy in this country. The only way to truly place this in perspective is to start with the Federal Reserve’s statutory mandate which is to “promote maximum employment, stable prices, and moderate long-term interest rates.”
Here is how that translates to today’s economy.
- Unemployment is below the Fed’s maximum employment target
- Prices are as stable as they have ever been in the history of the country, and
- The yield on a 30 year Treasury yield is 50 basis point above its all-time low.
Amidst that environment, (which also includes all-time highs for the equity market) the Chairman of the Federal Reserve indicated he is prepared to deliver preemptive rate cuts. The key line in the prepared statement signaling the move was “…based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted."
During the three hours of Q&A, Chairman Powell clearly signaled a dovish outlook, which quickly brought the return of escalating hopes of a larger 50 basis point easing move later this month.
It was remarkable to watch Congress "congratulate" a clearly politicized Powell for maintaining his “independence,” as he prepares to deliver a rate cut to an economy with near record economic readings. The only area where Powell deserves credit is that he was unequivocal in expressing that he is unabashedly dovish. That said, that message required that he backtrack on comments he made a few weeks ago, as well as contradicting himself today.
Recall Powell’s FOMC press conference statement. “So we want to see, and we want to react to developments and trends that are sustained, that are -- that are genuine and not react just to data points or just to changes in sentiment, which can be volatile.”
Today, there are no trends and Powell described the areas of concern by explaining, “We think that uncertainty around trade policy and also global growth, it's not all down to trade policy, there's something going on with the growth around the world, particularly around manufacturing and investment and trade. And so that uncertainty is, as we think, weighing on the domestic economy, it's starting to show up a little bit, we think in business sentiment readings which have moved down and also in a weaker business fixed investment.”
Evidently, sentiment is now a meaningful input. The Fed Chair won’t admit it, but the global manufacturing slowdown is largely attributable to the trade war. Powell repeatedly soft sold trade policy with lines like, “I guess I ought to start by saying that no one should interpret what I'm saying about trade headwinds as in any way a criticism of trade policy.”
The Chairman contradicted himself today when he discussed the labor market. Powell started off by down playing the labor market. “I would start by saying that we don't have any basis or any evidence for calling this a hot labor market.” Then several times throughout the session, he described the labor market as “tight” and made repeated statements such as, “We're at 3.7% unemployment, that's a 50 year low –a 50 year low, and we've been there for 15 months, and there's no reason why that can't continue.”
As the statutory mandate notes, the Fed is expected to support “stable prices.” The formal 2% price target was a creation of the Bernanke Fed. The chart of the 5 year rolling standard deviation of monthly Core PCE illustrates that inflation is remarkably stable. Today was the first time since the formal target was adopted in 2012 that a Fed Chair expressed that 20-30 basis points below target is something that needs to be addressed by policy. Powell noted, “I think we want inflation to be symmetrically at 2 percent and not at 1.7 or 1.8 percent because that will ultimately -- lower inflation will ultimately work its way into expectations and into short-term interest rates.”
It is ridiculous to think the FOMC can keep inflation precisely at 2%, and Powell should be embarrassed for insinuating they would try. The Fed is moving towards mission drift and none of its officials realize it. Another remarkable aspect of the inflation infatuation is that low stable inflation is one of the few benefits the American populace has received from globalization. Since monetary policy has driven massive wealth inequality over the last decade, the Federal Reserve is seeking to diminish the one benefit Main Street America has received.
When it came to questions as to whether the Fed’s inability to unwind its balance sheet and comparisons to Japan, Powell noted “What Japan has found itself in, is a situation where inflation has gotten down close to zero for a very long time and they've tried many, many things including, as you mentioned, extensive asset purchases and all sorts of forward guidance to move inflation back up and have not met with much success although they continue to struggle to do that.” After noting that Japan’s asset purchase policy failed, he noted that there would be “no shortage of treasuries” to buy in the instance the Fed wanted to launch a new Quantitative Easing program.
Jay Powell would have been better off indicating that despite the economic data, he plans to cut rates as a precautionary measure because there are meaningful reasons to be concerned about the outlook. He may very well know the trade stalemate with China is far worse than the Administration publicly lets on. Obviously, genuine concern would likely spook markets. Instead, Powell spoke out of both sides of his mouth, contradicted himself and kowtowed to the Administration by excusing the role of trade policy. Within a year of the President commencing his criticisms of Jay Powell, the Fed Chairman has performed a 180 degree about face on monetary policy, lacking the data to justify the reversal.
At this point, he has no credibility left and his only value as the Fed Chair today is that he is better than anyone the President would appoint to replace him. He is a Federal Reserve figurehead as the markets and the President call the shots on monetary policy, but Congress will continue to congratulate him on his “independence” because everyone likes rate cuts.
It is likely this will all come to an ugly end under his watch, and he will pay the price for ceding his independence.
This is a Hedgeye Guest Contributor research note written by Mike O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.