When Jay Powell spoke at the Jackson Hole symposium on Friday, the high-wire act he has performed since taking the helm of the US central bank in 2018 was again on full display.
Having balanced a robust economic expansion, surging inflation and sky-high asset prices with fast-rising Covid-19 cases and the fact that nearly 6m more Americans are out of work than before the pandemic, the Fed chair took a step towards dialling down monetary stimulus while conveying a steady enough pace to avoid fireworks.
Even as Powell suggested the $120bn monthly asset purchase programme that has fuelled the historic rebound in financial markets since the depths of the coronavirus crisis would be scaled back this year, US stocks roared to new heights and Treasuries rallied.
The Fed has long said it would maintain that pace of bond-buying until it saw “substantial further progress” on its goals of average 2 per cent inflation and maximum employment. On Friday, Powell declared the first of these thresholds met, with “clear progress” on the second.
“It was as balanced a picture as one might expect from Powell,” said Raghuram Rajan, a professor at the University of Chicago Booth School of Business and former governor of the Reserve Bank of India. “He is trying to buy time and does not want to set anything in stone.”
Powell’s task was made all the more complicated by a vocal and growing cohort of Fed officials who back a swift removal of policy support. Leading up to the chair’s speech on Friday, the “hawkish” faction of the Federal Open Market Committee redoubled their calls for tapering to begin to fend off higher inflationary pressures and to avoid transforming frothy financial markets into more worrisome bubbles.
Esther George, president of the Kansas City Fed — which hosts the Jackson Hole symposium each August — along with James Bullard of St Louis back a more immediate move, while Raphael Bostic, president of the Atlanta Fed, said tapering should start in October.
Loretta Mester, president of the Cleveland Fed and a voting member of the policy-setting committee next year, told the Financial Times on Friday that she supported wrapping up tapering by the second half of 2022 in order to have “space” between the end of those purchases and interest rate increases.
“I would like to have asset purchases completed before we even start to think about what to do with interest rates,” she said. The middle of next year gives us plenty of time to deal with [the data] before we think about lift-off.”
While Powell did not indicate a specific tapering timeline and reaffirmed his view that the recent rise in US consumer prices will fade over time despite supply chain constraints lasting longer than many anticipated, his concession that asset purchases should be reduced this year helped to further unify what has in recent months been a divided Fed.
“His main accomplishment [on Friday] was that he was respectful of the will of the committee,” said Vincent Reinhart, a former Fed economist who now serves as chief economist at Mellon.
But Powell’s emphasis on the uneven nature of the economic recovery, the further strides needed in employment, and the risks that come with prematurely tightening policy all helped to maintain the Fed’s flexibility to proceed more slowly, especially if Delta-related concerns become more prominent, economists said.
“What we are seeing is an unusual combination of labour market dislocations and an inflationary impulse that looks unlikely to persist for the long-term. In that situation, a central bank that pulls the trigger quickly on removing accommodation could be in the process of making a serious policy mistake,” said David Wilcox, a senior fellow at the Peterson Institute for International Economics and a former Fed staffer.
“It will take extraordinary patience, fortitude and a ton of credibility for the Federal Reserve to wait and see if inflation abates as they have been expecting and if the dislocation in the labour market wanes so that we can get back closer to pre-pandemic conditions.”
Nathan Sheets, chief economist at PGIM Fixed Income and a former under-secretary at the US Treasury, said Powell also succeeded at Jackson Hole in adequately preparing investors for an eventual policy pivot, so much so that tapering is gradually becoming a “non-event”.
Investors already expect the Fed to make an announcement in November in preparation for a December start. Interest rate increases are even further off, especially given Powell’s insistence on Friday that any tapering timeline would not confer a “direct signal” for when the Fed would raise rates.
“The failure to separate those two policy moves is what led to the taper tantrum in 2013,” said Ellen Zentner, chief US economist at Morgan Stanley, referring to the intense market volatility that followed after then-Fed chair Ben Bernanke surprised markets by hinting at a reduction in stimulus. “The Fed has learned its lesson that it needs to provide clear communication before policy changes.”
Layering on another complication for Powell is the ongoing debate about his future at the Fed. His four-year term ends in early 2022, and the Biden administration is discussing whether they will reappoint him or acquiesce to more progressive Democrats who have called for his replacement.
“He is making these really fine-tuned, difficult and complex decisions against the reality that every word he says is effectively an audition with the Biden administration for another term,” said Sheets at PGIM Fixed Income.
Additional reporting by Kate Duguid and Joe Rennison in New York