Fra BNP Paribas:
Chair Powell’s speech at Jackson Hole primarily focused on uncertainty around real-time
estimates of r*, NAIRU, and potential growth.
The speech reinforces our view that the Committee will remain guided by incoming data and cautious, likely becoming more nimble the closer rates go towards neutral levels.
We think the economy will start to show signs of a slowdown following the March 2019
meeting, with an increasingly nimble FOMC reacting by pausing its hiking cycle.
Chair Powell’s speech at Jackson Hole was largely focused the uncertainty around real-time
estimates of the “stars” – i.e. the neutral rate of interest (r*), the non-accelerating inflationary rate of unemployment (NAIRU, or u*), and the rate of potential growth (g*).
With heightened discussion over the level of neutral interest rates, and with regional Fed presidents offering their own estimates, Chair Powell’s speech reinforced that the Committee will ultimately remain data dependent. At the same time, we expect its reaction function to change as rates approach neutral, with it becoming increasingly more nimble to signs in the data as it does so.
Powell cites two historical examples warning of abiding too closely to such real-time estimates. During the Great Inflation period of the late 1960s to early 1980s, Powell faults overly optimistic real-time estimates of NAIRU as a key factor in the FOMC keeping policy too loose, contributing to runaway inflation.
On the flip side, Powell praises Chair Greenspan for “avoid[ing] the GreatInflation-era
mistake of overemphasizing imprecise estimates of the stars,” trusting his hunch of
a productivity boom instead of real-time estimates of NAIRU and potential growth, and relying on the strategy if waiting meeting-to-meeting for signs of inflation before tightening.
In discussing these two historical examples, the clear takeaway is to be cautious of relying too much on estimates of the “stars”, as “the stars are sometimes far from where we perceive them to be”. At the same time, Powell notes that a flat Phillips Curve (i.e. lack of a relationship anymore between resource pressures and inflation) could make Greenspan’s strategy of waiting on signs of inflation to indicate tightness in the labor market no longer useful. Powell notes that in the run-up to the past two recessions, it was in the financial markets where destabilizing excesses appeared.
Powell concludes that modern-day risk management suggests “looking beyond inflation for
signs of excesses,” with the “risks from misperceiving the stars also now play[ing] a prominent role in the FOMC’s deliberations”. Powell lastly cites the recommendation of William Brainard, that “when you are uncertain about the effects of your actions, you should move conservatively” (though Powell excepts this recommendation when reacting to financial crises or when inflation expectations threaten to become unanchored).
In all, the takeaway from Powell’s speech for us is cautiousness as the Committee continues its gradual rate hikes, and continued reliance on a meeting-to-meeting data dependence (with that data comprising a wide range of indicators and specifically not contingent on inflation moves). Despite clearly expressing uncertainty over estimates of r*, we think that the Powell Fed wil become increasingly nimble in terms of its reaction function to data as it pushes rates closer to estimates of neutral.
For us, this means that if the data begins to show signs of slowing, the Committee will likely
become more prone to react to that slowing. Or, if the data remains robust, the Committee could be similarly nimble in concluding that it needs to continue to push rates higher. As we see the effects of fading fiscal stimulus, tighter financial conditions, a downshift in global growth momentum beginning to show in the data around Q2 next year, we expect the Powell Fed to abide by this risk management strategy, and elect to pause its hiking cycle after getting in hikes in September and December of this year, and March of next year
