“Everybody says don’t … it isn’t right; Don’t, it isn’t nice,” wrote Stephen Sondheim for one of his musicals. A diverse chorus sang those lyrics to Federal Reserve Board chairman Jay Powell. From the center-left of the choir Powell could hear Larry Summers, Bill Clinton’s treasury secretary, “I do think that there are more risks of over-tightening than there are of under-tightening.” From the center came the voice of Kevin Warsh, former Fed governor now at Stanford University’s Hoover Institution, “Given recent economic and market developments, the Fed should cease – for now – its double-barreled blitz of higher interest rates and tighter liquidity.” From the center-right another former Fed governor, Larry Lindsey, sang “The Fed should not raise rates.” And, The Wall Street Journal the voice of the business community, called for “a prudent pause in raising rates.” Earlier, a voice, impossible to place on the usual political spectrum, could be heard from the White House, shouting rather than singing, “I think that the Fed is way off-base with what they’re doing.”
A discordant note was struck by Jamie Dimon, CEO of JPMorgan Chase, “It’s a strong economy and normalizing rates is a good thing today … I think rates should be 4%.” Fortunately for JPMorgan’s shareholders, Dimon’s view of the national interest coincides with the interest of the bank he runs. Higher interest rates mean more revenues for the bank, which, like other big banks, passes those increases on to its customers more quickly than it does to its depositors.
Powell ignored all those “don’ts” and took Sondheim’s advice, “I say do.” He raised the central bank’s benchmark interest rate to a range of 2.25% and 2.50%, its ninth increase since it began ratcheting rates up in 2015, and its fourth this year. In addition, he announced that the Fed’s monetary policy gurus are planning two rate increases next year (instead of three, as earlier planned) and will continue to sell $50 billion per month in assets from its bloated balance sheet, draining cash and liquidity from the economy (QT, or quantitative tightening), potentially causing more pain than the interest-rate increases. Take that, Mr. President.
The Fed chairman can take pride of some sort in the fact that when he talks, the markets listen. The Dow was up 381 points when Powell rose to speak. As he droned on and then answered questions it fell by some 732 points to close down 351 points (1.5%), its low of the year. That’s power.
To be fair to the Fed policy gurus, who voted unanimously to support Powell, they have to steer between the Scylla of plunging share prices and the Charybdis of an overheating economy, between a President unhappy with his appointed chairman, and many economists who feel the economy is strong enough to survive being taken off the zero-interest rate life support system concocted by the Bernanke Fed when the international financial markets flirted with collapse in 2008.
Underlying this debate is the received wisdom that the Fed should keep the inflation rate at or around 2% per annum, and aim for a “neutral” benchmark interest rate of about 3% — one that will neither stimulate nor cool the economy. The 2% figure it was first used in New Zealand, Australia and Britain in the 1990s, but how it was arrived at remains a bit of a mystery. So is the origin of the 3% figure for that matter. And so is why the Fed worries about inflation at all. The inflation rate is running below 2% for the seventh consecutive year, and is expected to stay what Powell calls “low and stable” in 2019. Why drop a lump of coal – what the President calls “beautiful, clean coal” — into traders’ Christmas stockings when there is no sign of the inflation that rate increases are designed to prevent?
Powell believes the economy is in fine shape: it grew 3% this year, unemployment continues to fall, paychecks are rising, especially for the lowest paid. GDP grew at an annual rate of 3.4% in the third quarter. Growth is expected to slow in 2019, but not by much. Powell admits that there are headwinds, but not of sufficient force to blow away the prosperity we will continue to experience. He might be right: consumer spending remains at high levels, despite which the savings rate stands at the healthy level of more than 6%, twice what it reached before the last recession. This gives households plenty of spending power as they recover from their new year revelries.
But he might be wrong. The interest-sensitive housing and auto markets are slowing as higher interest rates make it more expensive for consumers to buy homes and vehicles. Rising mortgage rates are driving profits down and vacancy rates up in the commercial property sector, which bodes ill for future construction activity. The oil industry is struggling as falling prices hit producers hard. The effect of the tax cuts is expected to fade next year. And neither China nor Germany is likely to contribute much to global growth in 2019, even though China will loosen fiscal policy.
Nevertheless, up went rates, with more increases and asset sales on the calendar. Powell admitted, “There’s a fairly high degree of uncertainty about both the path and the ultimate destination of any further increases.” Fed actions will remain “data driven”. Translation, “I know our forecasts are often wrong, but don’t worry. We’re not bound by them.” Or, as John Maynard Keynes is alleged by disciple Paul Samuelson to have claimed, “When events change, I change my mind.” Perhaps when Powell spoke last week he would have been better served by a bit of “agnosticism,” as Larry Summers, a more recent Keynes disciple and Samuelson’s nephew, since suggested. Absent that, he has “data-driven” on which to fall back in a pinch. And bear the “I told you so” from the White House.