Powell vs. the Fed, and the Winner is…

The Federal Reserve Board’s monetary policy committee announced last week the fourth consecutive 0.75% increase in its benchmark interest rate, bringing it to a range of 3.75% to 4%, still negative when inflation is taken into account. No surprise. That came when it advised that “in determining the pace of future increases … the Committee will take into account the cumulative tightening of monetary policy, [and] the lags with which monetary policy affects economic activity and inflation.”

That could only mean that it was considering a pause to give the cumulative and long-run effects of its  increases time to bring the 6.2% inflation rate, its preferred measure, closer to its 2% target. Smiles and soaring share prices on Wall Street.

Then Fed Chairman Jay Powell took the podium to conduct a press conference, and do an imitation of a released hostage repudiating a coerced statement. He rejected the Fed statement, wiping smiles off traders’ faces and the price gains off share prices. Powell the predatory hawk made a meal of the staff doves who had drafted the committee’s statement.

He warned it is “very premature to even talk about pausing … we have a ways to go on rates.” Although the economy shows signs of slowing, “wage growth [is] elevated … the labor market continues to be out of balance … inflation data have again come in higher than expected … the longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched.”

Worse: he now says the end point of these increases will be higher than the 4.6% interest rate he once thought, and that the risk of a tightening overshoot, which the Fed can correct, is less worrying than an undershoot. Larry Summers believes we might end up above 6%, which would portend not a mere hard landing, but a crash landing.

Eyes rolled, heads spun as reporters tried to make sense of what they were hearing after what they had read only minutes before in the formal committee statement. “Faced with cognitive dissonance of this magnitude, the mind struggles for explanations,” commented the Lindsey Group, a consultancy well-known for its perceptive analyses of Fedspeak.

One thing is clear: the labor market is driving Fed policy. The economy added 261,000 jobs in October, about half the average number last year. The unemployment rate ticked up from 3.5% to 3.7%. All are signals of a slight easing, but not of a weakness that would cause a Fed re-think.

The Fed also is considering that long-term unemployment (27 weeks or longer) is as low as it has been in twenty years. Job openings, which dipped a bit in August, rose to 10.7 million in September, about two for every job seeker. And employees faced with rising prices for eggs, milk and bread, up this year by 40, 20 and 16%, respectively, are unlikely to moderate wage demands. Workers who haven’t changed jobs have already wrested 8 % increases, job-jumpers twice that. Interesting titbit in the data: The number of workers under 25 and over 55 increased while the number of prime-aged workers dropped by half a million, prompting one to wonder where have all those workers gone since they cannot have gone to graveyards every one. One “career coach” says the days of a booming job market are over and these people might be in for an unpleasant surprise, “I watch the train wreck in slow motion. All these people thought ‘Oh, when I’m ready to go back to work it’ll be no problem.’ And now it’s a problem.”

News from the consumer front reinforces Fed determination to continue tightening. Consumers remain willing to spend, not quite as much as in the recent past, but enough to keep the economy moving ahead at an annual rate of around 2.6%. Shoppers are descending on stores in about the numbers they did before the pandemic. Restless Americans are providing American Express with strong travel-related bookings. Airlines remain overbooked, hotel reservations hard to come by until after Christmas.

But consumers are drawing down savings built up during the pandemic. The personal savings rate as a share of disposable income fell to 3.3% in the third quarter, the lowest level in over seventy years and far below the more-than 20% rate of the days of lock-downs and government checks. Credit card usage has increased to pre-pandemic levels, with loan balances carried from month-to-month rising, although not dangerously.

The information on jobs and spending combines to support Powell’s opinion that the Fed still has work to do. It has so far succeeded in cooling the housing market – a more than doubling of interest rates on typical mortgages from around 3% to 7% will do that. The inventory of unsold houses is up and bargaining power has shifted to buyers, many of whom are fleeing from urban areas not to suburbs, but to rural areas. Prices of new cars have declined slightly. Anecdotal evidence suggests bargaining power in some sectors is shifting from workers to employers: “The trend has been toward less bargaining power for workers,” Nick Bunker of “career site” Indeed told The New York Times and a survey by Flexjobs found that 73% of job seekers say the possibility of recession is affecting their decisions.

Another possible reduction of price pressure comes from the fact that retailers are unloading excessive apparel inventories at bargain prices. But goods inflation is not coming down as fast as the Fed thought it would, and services inflation is picking up. Policy now is “higher and longer” – the benchmark interest rate will be above 5%, and maintained for a long while.

Powell says the runway for a soft landing is narrowing. Perhaps not.

·       Fed rate increases might bring down inflation after the inevitable lag.

·       Wage pressures might be reduced by a  reduction in job openings rather than in jobs.

·       Consumers, having binged on their pandemic savings, might rein in spending.

·       On Tuesday voters might replace a free-spending government with a divided one, too deadlocked to pass spending bills.

In short, with a little bit of luck Powell might not run amuck. But only “might”.