Jerome Powell

How Wall Street Listens to the Fed

Since the economy-crushing lockdowns of last year’s pandemic, the Federal Reserve has been doing what it does – trying to breathe life into the economy.

And so the Fed has been buying $120 billion in treasury and mortgage backed bonds every month for nearly the last year and a half. 

Obviously that can’t go on forever — at least not if you want to appear fiscally responsible. 

So Fed Chairman Jerome Powell recently commandeered the airwaves from the Fed’s virtual Jackson Hole retreat to announce the Fed’s plan for tapering to the market. 

It was an excellent example of “Fed-speak.”

The Mind-Boggling Rhetoric of the Fed

My firm belief is that anyone who rises to the level of sitting on the board of the Federal Reserve must have an advanced degree in rhetoric. (Or just a natural ability to talk a lot without actually saying anything.)

Because the ability to spew large amounts of words without actually saying anything is pretty much paramount to the job. Things like…

“As is typically the case, the recovery in employment has lagged that in output. Nonetheless, employment gains have also come faster than expected.”

So is employment moving too slow or too fast? 

Absolutely!

Right now, most of the financial system is watching to see when the Fed will pull the plug on its monthly bond buying spree and possibly — possibly — tighten monetary policy. That, of course, will depend on the prospects for future inflation.

Let’s look at some of what Chairman Powell shared on that topic in his recent Jackson Hole speech to clarify the issue (I’ve provided a little translation along the way):

“The rapid reopening of the economy has brought a sharp run-up and inflation. Over the 12 months through July, measures of headline and core PCE inflation have run at 4.2% and 3.6% respectively, well above our 2% longer run objective.”

(So inflation numbers are, in fact, way above our target…)

“Inflation at these levels is, of course, a cause for concern, but that concern is tempered by a number of factors that suggest that these elevated readings are likely to prove temporary.”

“…spending on durable goods has boomed since the start of the recovery and is now running about 20% above the pre pandemic level. With demand outstripping pandemic-afflicted supply, rising durables prices are a principal factor lifting inflation well above our 2% objective.”

(But don’t let that worry you…)

“The durable goods alone contributed about 1% to the latest 12 month measures of headline and core inflation. Energy prices, which rebounded with a strong recovery, added another eight tenths of a percent to headline inflation. And from long experience, we expect the inflation effects of these increases to be transitory.”

(Durable goods and energy prices are the bad guys having added nearly 2% to those inflation numbers…)

“As supply problems have begun to resolve, inflation in durable goods other than autos has now slowed and maybe starting to fall. It seems unlikely that durables’ inflation will continue to contribute importantly over time to overall inflation.”

(But we don’t expect that to last…)

“…if wage increases were to move materially and persistently above the levels of productivity gains and inflation, businesses would likely pass those increases onto customers, a process that could become the sort of wage price spiral seen at times in the past.”

(Increasing wages also pose a threat as far as inflation goes…)

“Broad-based measures of wages that are just for compositional changes in the labor force, such as the Employment Cost Index and the Atlanta Wage Growth Tracker, show wages moving up at a pace that appears consistent with our longer-term inflation objective.”

(But we don’t think that’ll last long either…)

“Longer-term inflation expectations have moved much less than actual inflation or near term expectations, suggesting that households, businesses, and market participants also believe that current high inflation readings are likely to prove transitory.”

(In fact, nobody expects inflation to be a problem long-term…)

“While the underlying global disinflationary factors are likely to evolve over time, there is little reason to think that they have suddenly reversed or abated. It seems more likely that they will continue to weigh on inflation as the pandemic passes into history.”

(While we can’t be sure, we expect disinflationary factors will keep inflation in check…)

“To sum up, the baseline outlook is for continued progress toward maximum employment with inflation returning to levels consistent with our goal of inflation averaging 2% over time.”

(So everything’s under control…)

“History also teaches, however, that central banks cannot take for granted that inflation due to transitory factors will fade.”

(But maybe not…)

“At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.”

(If things stay good, we’ll start cutting back on our bond purchases…)

“Even after our asset purchases and our elevated holdings of longer-term securities, we’ll continue to support accommodated financial conditions.”

(But just the same we’ll keep the printing presses warmed up…)

“The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test.”

(And by the way, none of this means anything where raising interest rates goes…)

Now if you found Powell’s language a little hard to understand, don’t worry. It was supposed to be. 

It was a classic example of “Fed-speak” — a lot of impressive sounding stuff that’s just enough to placate the markets… for a while longer at least.

The More Important Thing to Listen For…

The really important thing you should take away from this speech is what Powell DIDN’T say.

Here’s the truth…  Top-down economic management doesn’t work. The Fed has no crystal ball. They can’t “fine tune” the economy like they pretend they can. In fact, those at the top usually get things wrong…

And despite all his reassurances, Jay Powell said virtually nothing about what the Fed was prepared to do if their assessment was wrong. What action would they take if inflation numbers were still at 4-plus percent two, three, or even four months down the road? What if inflation really isn’t transitory? 

Would they be willing to do what’s necessary to rein it in? Like Paul Volcker who let interest rates rise to near 20% back in the 1980s? 

In his entire speech, this was all he said:

“If sustained higher inflation were to become a serious concern, the FOMC would certainly respond and use our tools to assure that inflation runs at levels that are consistent with our goal.”

The Fed never says much when it talks about something. But smart investors listen to what they don’t say.

Make the trend your friend,

Bob Byrne
Co-founder, Streetlight Equity