FOMC Round Up: I Owe Jay Powell an Apology

I think I’ve been too hard on the Fed and its Chairman Jay Powell.

In past writings on “Fed-speak” and other related topics, I think I’ve made it seem like the Federal Reserve is a no good, lying, cheating, thieving criminal organization. They’re not. 

Those would be the banks on Wall Street. 

The Fed is more like… a PR company. Their job is to make the fantastic seem real. To make bad times seem, if not good, then at least not so bad. And if that wasn’t tough enough, they do it while shoring up miscreant member banks, who usually cause all the problems in the first place, and make it seem like it’s all in your best interest.

So when Chairman Powell steps to the podium every couple months, he doesn’t go out there to lie. He goes out there to spin. To deliver a narrative that will make whatever ridiculous action they’re taking — whether it’s printing $120 billion a month to fund the government or mortgage industry or crushing interest rates to negative real returns — seem totally reasonable.

And after decades of creating alternative language (like real estate “froths” and “quantitative easing”) that papers over whatever crisis the economy is suffering… boy are they good at it. 

But all this is not entirely Powell’s fault. Fed Chairman is a thankless job. It requires him to take the heat when times are bad. It requires him to be a congressional whipping boy when politicians need a body to throw under the bus. And he never, ever gets to stand up and say “Who run Bartertown?!?!”

(Even though he basically does.)

So in light of all that, if I have been overly critical, my apologies to Chairman Powell. 

He was back at the mic again last week taking more heat. He announced the FOMC raised its interest rate target by 75 basis points — no surprise there. 

He delivered the bad news that some things were “off” in the economy: consumer spending has slowed, the housing sector has softened and business investment has dropped off.

But there was good news too: unemployment is at 50-year lows, non-farm jobs are expanding month after month and wages are on the upswing.

And then there’s the little problem of inflation. But they know what’s behind it…

Notwithstanding the recent slowdown in overall economic activity, aggregate demand appears to remain strong, supply constraints have been larger and longer lasting than anticipated, and price pressures are evident across a broad range of goods and services.

In theory, strong demand should be good news. But today, for Powell’s PR purposes, it has to be the bad guy.

Beyond that, there were three big questions that came out from this month’s Q&A. Let’s take a deeper look at how he spun them…

(I’ve edited the copy below for length. And all the emphases are mine.)

How High Will Rates Go?

With the Fed on an interest rate raising rampage, the question on everyone’s mind is, how high they need to go before inflation finally gives in.

Q: As the Committee considers the policy path forward, how will it weigh the expected decline (in) headline inflation which might come as a result of the drop in commodity prices against the fact that we are likely to see some persistence in core readings in particular? …how has the Committee’s thinking changed on how far into restrictive territory rates may need to go?

JP: So, one thing that hasn’t changed– won’t change is that our focus is going to continue to be using our tools to bring demand back into better balance with supply in order to bring inflation back down.

Consistency is critical to a successful PR campaign. So he basically echoed what he said in May and June — they’ve got to kill demand to tame inflation. Naturally there’s only one way to do this with the tools they have and it starts with the letter “R.” (But that’s another topic to avoid.)

You should also note that the reporter mentioned the impact of declining commodity prices. I’ll come back to that at the end of this essay…

So how high do rates have to go to put demand on life support?

We’re at 2.25 to 2.5 and that’s right in the range of what we think is neutral.

I think the Committee broadly feels that we need to get policy to at least to a moderately restrictive level. And maybe the best datapoint for that would be what we wrote down in our SEP at the June meeting, so I think the median for the end of this year, the median would have been between 3 and a quarter and 3 and a half.

So there’s spin No.1: That 2.5% funds are “neutral” — meaning they don’t impact the economy one way or the other — is just plain fantasy. The Chairman is pushing 70 years old, certainly old enough to remember the 90s when Fed Funds averaged around 5.75% during a bull run that took the S&P 500 from 300 to over 1500. 

Source: Federal Reserve Bank of St. Louis

By that logic, 5.75% should be stimulative to the markets. So this is just made up.

And if he thinks the June Summary of Economic Projections (SEP) median rate projection of 3.4% will be restrictive… we’ll just have to see about that. 

The “R” Word

More than one reporter asked about the elephant in the room… the “R” word. By and large, like any good PR man, he deflected from the subject and shifted the narrative back to controlling inflation.

…as I’ve said on other occasions, price stability is really the bedrock of the economy. And nothing works in the economy without price stability.

But enough pressure from the gallery forced the issue…

Q: …do you believe the United States is currently in a recession? Will the GDP reading tomorrow affect that judgment one way or the other? And has your assessment of the risk of recession changed any in recent weeks?

JP: So, I do not think the U.S. is currently in a recession. And the reason is there are just too many areas of the economy that are performing too well. And of course, I would point to the labor market, in particular. As I mentioned, it’s true that growth is slowing. For reasons that we understand. Really the growth was extraordinarily high last year, 5 and a half percent. We would have expected growth to slow. There’s also more slowing going on now. But if you look at the labor market, you’ve got growth, I think payroll jobs averaging 450,000 per month? That’s a remarkably strong level for this state of affairs. The unemployment rate at near 50-year low at 3.6 percent. All of the wage measures that we track are running very strong. It doesn’t make sense that the economy would be in recession with this kind of thing happening. So, I don’t think the U.S. economy’s in recession right now.

Where to start with all this?

Yes, GDP reportedly grew by 5.7% in 2021. But factor in the annualized inflation of 7% and “real” growth was more like -1.3% for the year.

The “payroll jobs” averaging 450K per month (a rough average of the first six months of 2022) doesn’t represent a broad trend in employment as I explained two weeks ago. Labor participation is still significantly below pre-pandemic levels suggesting a major employment shift is brewing in the economy…

Labor Participation


Forget Unemployment… It’s one of the most manipulated numbers the government puts out.
And wages… While they have been rising, they’re nowhere near keeping up with inflation. At least not according to the BLS.

It was impressive spin though!

What About the Other Elephant in the Room?

Q: Right now there’s a sort of growing gap between the Fed’s preferred measure of inflation, the PCE index and the one that’s followed by the public, the CPI. How do you expect to handle this divergence if the PCE starts to come down enough for you to consider slowing rate hikes, even if the public is still seeing much higher CPI ratings?

JP: So, it’s an interesting situation. Of course, we’ve long used PCE because we think it’s just better at capturing the inflation that people actually face in their lives. … That said, the public really reads about CPI. … Given the importance in the public eye of CPI, we are calling it out and noticing it and everything like that. But remember, we do target PCE. That is because we think it’s a better measure. … So we’ll be watching both, but again, the one that we think is the best measure always has been PCE. At least since I think we– some 20 plus years ago moved to PCE.

Another brilliant non-answer (and actually they’ve only used PCE for 10 years). 

In 2012 the Bureau of Economic Analysis began calculating the Personal Consumption Expenditure Price Index (PCE) — an alternative to the Bureau of Labor Statistics’ more traditional Consumer Price Index (CPI). 

Both track a basket of consumer goods. But that’s where the similarities mostly end. 

There’s actually a number of differences between the two. More than we can cover in any depth here. But let me highlight a couple of the bigger ones via the Cleveland Fed.

One difference is called the “weight effect” which factors the importance of every item in the index. For example, gas would have a higher weight than apples. Both indexes weight items differently.

Additionally, the CPI basket is based on a survey of what households are buying while the PCE basket is based on what businesses are selling

A second difference is called the “coverage” aspect. While the CPI only counts out-of-pocket expenditures, the PCE index factors in payments made by third parties — like your health insurance.

Finally there is what’s known as the “formula effect.” The indexes use two completely different formulas which account for changes or substitutions in each basket. The PCE index factors in short term substitutions while the CPI only updates the products in its basket every two years

The validity of one measure over the other has been the subject of debate forever. And the PCE Price Index is often called a more reliable measure of the cost of living.

But is there another reason the Fed prefers PCE?

Economist John Williams of ShadowStats makes, what I think is, a very important distinction…

I contend that individuals look to the government’s CPI as a measure of the cost of living of maintaining a constant standard of living, as well as measuring that cost of living in terms of out-of-pocket expenses.

In other words the PCE’s “dynamic” basket measures monthly costs while the CPI’s “static” reflects the cost to maintain a standard of living. Which may seem trivial, until you’re forced to start buying your groceries at the local Dollar Store…

The Fed’s Real Dilemma

The Fed’s back is to the wall where inflation is concerned — they understand (and admit) that getting it under control has to be their top priority. And as I’ve written before, they can only accomplish that by choking off demand.

Which will only happen as we plunge into recession. 

Of course, they have to deny that at every turn.

But we’re already on our way (if we’re not there already).

Earlier I mentioned one reporter’s comment on declining commodity prices. It’s true. Most raw commodity prices have been in decline for some time. (I pointed it out in July.) Unfortunately they won’t be showing up at the grocery store for some months. 

The reason they have is because markets, which are forward-looking, are already anticipating a recession. 

And yet another warning I’ve shared before, the yield curve has fully inverted suggesting that markets are looking for rates down the road to come down to accommodate the coming recession. (The only real question is where they’ll have to come down from…)

Source: Federal Reserve Bank of St. Louis

The good news for the Fed, from a PR perspective, is that where recessions go, there’s no hard and fast definition of what one is. 

The “technical” definition is two consecutive quarters of economic contraction. We’re already there. The “official” definition is when the economists at the NBER say so. We may not be there for another year. 

Chairman Powell even has a definition: “a  broad-based decline across many industries that sustain for more than a couple of months and there are a bunch of specific tests in it.”  I’m sure he’ll let us know when that happens. 

So given there’s no official consensus, like any good PR firm, they can keep spinning economic bright spots and deny we’re anywhere near a recession while taking credit for any price declines. 

The other good news for them is that, much like recessions, there’s no hard and fast definition of stagflation either…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential