With expectations for a very hawkish Fed, many were still looking for some sign of mischief from Chair Jay Powell at the latest Fed meeting. For example, he could have said the Fed would remain data dependent, easing policy if the data improved. Or there were signs that inflation was starting to moderate.
Instead, what he said was that the Fed is determined to keep hiking rates and keep rates high until inflation returns to 2 percent — which isn’t expected until 2024 at the earliest and possibly 2025. He said incredibly, that the Fed had to get inflation down despite economic costs. He said (not explicitly, but implicitly) that the Fed would stay even if we had a recession. And he said that the only possible way to reduce inflation is to significantly increase unemployment.
So much for hate.
A real surprise
There are two takeaways from this, and the second is more worrying. The first is simply that the Fed is committed to bringing inflation down to target levels, and that’s not a surprise or particularly newsworthy. At least that’s been the message since Powell’s Jackson Hole speech. In fact, he began yesterday’s press conference by saying that the message was similar to that of Jackson Hole.
No, the real surprise from yesterday is that the Fed is now expecting a multi-year project to reduce inflation and that it expects a recession, possibly a bad one. Powell made it clear that the Fed doesn’t know how bad it will get — the expected growth and unemployment numbers are already bad — but that it will continue regardless. The surprise is that the Fed expects inflation to be higher for a longer period of time and therefore interest rates to be higher for a longer period of time. It’s wrong to expect markets to pick up some time next year. And, looking at the data, almost the entire board seems to agree.
So much for hate.
Change in expectations
Surprisingly, after having a night to digest it, the markets are reacting. Yields on the US Treasury 10-year note rose sharply, taking us back to pre-financial crisis levels for the first time since late 2009. Higher rates mean lower stock valuations, and markets are bearish across the board. Powell was right, his message was the same as Jackson Hole, but even more so, and the markets are responding in kind.
It changes expectations going forward. Markets had priced in a rate cut next year, but that’s unlikely if Powell is right. Markets have priced in a peak rate of around 4.5 percent, but that may not be enough. The future looks much riskier from a monetary policy perspective now than it did 48 hours ago.
Economic risks are increasing
This looks risky from an economic point of view. The main bright spot so far has been strong job growth, and the Fed now has that in its sights. Understandable—it’s driving excess demand that’s keeping inflation high—but a bad sign for overall growth. And by saying that a recession wouldn’t necessarily loosen policy, the Fed removed a safety net under the economy.
Are things different this time?
So, yesterday’s real message wasn’t Hawken – we knew that. The real message was that the Fed now only sees inflation as its mandate. Jobs, economic growth and markets can all be, and will be, sacrificed to bring inflation under control. Greenspan/Bernanke/Elaine Putt is dead, and we’re back to the future with Paul Volcker’s policies.
It will take some getting used to, and Powell and the board may not be able to sustain it. But for the moment, things look really different this time around.