Powell Smartly Swears Off Guidance But Then Doles Some Out

Even so, markets weren’t listening closely, or traders opted to hear what they wanted to hear.

<div class="paragraphs"><p>A monitor with Jerome Powell, chairman of the U.S. Federal Reserve, speaking during a news conference. (Source: Bloomberg)</p></div>
A monitor with Jerome Powell, chairman of the U.S. Federal Reserve, speaking during a news conference. (Source: Bloomberg)

Federal Reserve Chair Jerome Powell made waves in financial markets Wednesday by saying that rate increases will eventually slow and that he will refrain from “clear guidance” on the path of future ones. That contributed to the huge rally in stocks and bonds Wednesday, with the Nasdaq Composite Index posting its biggest jump since April 2020. The funny thing is, Powell actually did provide quite a bit of forward guidance in his press conference after the central bank’s rate decision — traders just opted to ignore it.

So why would financial markets celebrate these comments anyway? It’s complicated, but the general idea is that the Fed isn’t as set in its commitment to higher interest rates as originally thought. It’s open to making policy as the data dictates. Of course, the Fed has a dual mandate to promote maximum employment and stable prices, and the US economic expansion is clearly coming to a crossroads. Naturally, some investors think that incoming data on a softening economy could scare the Fed away from further tightening.

That’s misguided though. Speaking Wednesday after raising interest rates by 75 basis points, Powell said he thinks stable prices are a precondition for the economy and job market to thrive in the long run. With inflation at a 40-year high and unemployment at just 3.6%, it’s clear that the balance of priorities is on fighting inflation and will remain so for the foreseeable future.

But how high will the Fed lift interest rates to achieve its goals? One clue Powell offered Wednesday was that the estimates policy makers published in June in the Summary of Economic Projections, or SEP, remained “broadly in line” with the Fed’s current thinking on the destination of policy rates. Those estimates showed that the median estimate of Federal Reserve Board members and Federal Reserve Bank presidents was for a 3.8% federal funds rate for the end of 2023. That’s significantly higher than the 2.85% rate that that fed funds futures markets currently implies after Wednesday’s rally. Here’s the full Powell quote:

We’re going to be guided by the data. And I think you can still think of the destination as broadly in line with the June SEP because it’s only six weeks old. And sometimes SEPs can get old really quick. I think this one I would say it’s probably the best guide we have as to where the committee thinks it needs to get at the end of the year and then into next year. So I would point you to that.

The other key piece of guidance Powell provided was a glimpse into how he thinks about the labor market, and that too was considerably more hawkish than market participants seem to grasp. For at least the second time since May, Powell said that he thinks the natural rate of unemployment — the rate associated with stable prices, below which inflation is pressured higher — may have increased. “I would say it must have moved up materially,” he said. 

Although the variable is highly theoretical and hard to observe in real time, it’s a critical component of the way economists think about inflation and the path of interest rates. Economists who have studied the matter think that the matching function in the job market may have broken down during the pandemic as the economy shifted from services to goods, as people moved geographically and as some workers remained constrained by Covid-19 concerns. Anna Wong, Bloomberg Economics’ chief U.S. economist, thinks that this shift in thinking on the natural rate of unemployment is enough to suggest the Fed may now have to push the federal funds rate as high as 5% in mid-2023. Powell seemed to validate that call with his last remarks on the matter.

In all, it’s clear that the stock and bond markets exhibited some selective hearing on Wednesday. Powell’s decision to abandon forward guidance may ultimately be a smart move. It means that the Fed won’t get locked into a path at a challenging moment with many confusing crosscurrents in the economic data. It also won’t risk hurting its credibility by saying something it can’t stand by.

Before the Federal Open Market Committee meets again on Sept. 20-21 to vote on monetary policy, it will get two consumer price index reports and two unemployment reports, which could well change its assessment of the circumstances. Unfortunately, the inflation problem remains so concerning that the Fed can’t possibly temper its aggressiveness as much as markets are apparently implying. So the end of forward guidance as a formal strategy is a reasonable decision, and if one thing is evident from the events of Wednesday, markets don’t listen particularly closely anyway.

More From Other Writers at Bloomberg Opinion:

  • Are Interest Rates at Neutral? Markets Hope So: Mohamed El-Erian
  • Why the Federal Reserve Should Keep an Open Mind: Editorial
  • Do You Think Fed Hasn’t Done Enough? Think Again: Nir Kaissar

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company's Miami bureau chief. He is a CFA charterholder.

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