Sometimes being Fed Chair is a trying easy job. During the last
post-FOMC press conference, Powell was given numerous opportunities to interpret the data in a hawkish fashion. Instead, he took a dovish tone.
As one of many examples, Jenna Smialek of the New York Times asked if strengthening in the labour market would be a reason to hold off on rate cuts. Powell’s response was, “No, not all by itself no.”
Even as Powell sounded a dovish tone, and markets took a risk-on tone as a relief that the median dot plot is still forecasting three rate cuts for 2024, not all is dovish within the FOMC. An analysis of how the 2024 dot plot evolved between December and March shows a mildly hawkish tone. Even though the median stayed at three cuts, the average fell and the distribution became far less dovish than the December projections.
The opinion of individual members of the FOMC has become more hawkish. If Powell needs to achieve a consensus for a rate cutting decision, it was be as difficult as herding cats.
Achieving a consensus
Powell faces a political problem. The tightening cycle is over. As the Fed holds rates steady and inflation decelerates, the real Fed Funds rate rises and monetary policy becomes increasingly restrictive. The right move is to cut rates. It’s only a question of when.
In this new era of more open communications, the Fed hates to surprise markets. Right now, the market consensus calls for the first rate cut at the June meeting. The evolution of the dot plot shows a hawkish evolution on the FOMC. Can a consensus be achieved to cut rates by June? If not, watch for guidance that the timing of the first cut will be pushed out.
While the Fed’s official view is that it doesn’t pay attention to politics to formulate monetary policy, it is an election year and FOMC members are undoubtedly aware of the optics of cutting rates in the second half of 2024 as the election approaches. The political pressure is already starting to build. Former Fed Governor Kevin Warsh, who is said to be a candidate for Fed Chair should Trump win the White House, went on CNBC and accused the Fed of goosing the economy even as asset prices melt up.
These are not ordinary times. Reading between the lines of Powell’s responses at the post-FOMC press conference, the Chair would like to cut rates, probably in June, but he is meeting resistance. Powell needs a decision to be unanimous in order to present a united front to the world as a way of deflecting criticism that the rate cut is a partisan decision to help Biden’s re-election.
Obstacles to a June cut
Here are the obstacles to a consensus decision to cut rates at the June meeting.
Starting with core PCE (blue bars), which had been good progress with a series of constructive sub 0.2% monthly prints indicating a disinflation. The more volatile headline PCE (red bars) even turned negative last November. The trend of decelerating inflation ended in January, followed by an elevated February level of 0.3%, Even though February was in line with expectations, January’s core PCE was revised up from 0.4% to 0.5%. Headline February PCE printed a downward surprise at 0.3%, compared to the 0.4% expected, but January was also revised up from 0.3% to 0.4%.
Drilling down further, consider the dynamics of the three major components of core inflation: goods, core services and shelter. Durable goods prices (blue line, left scale) spiked as a result of supply chain bottlenecks but they have normalized to near zero. Core services (red line, right scale) have been decelerating, but readings are elevated and far from the Fed’s 2% target.
Fed Governor Lisa Cook presented the accompanying chart in a speech last week which outlined how housing inflation is expected to evolve. The good news is leading indicators of PCE housing services is expected to decline for some time, which should be helpful moving overall inflation toward the Fed’s 2% target. The bad news is the leading indicators are bottoming and starting to edge up, indicating a re-acceleration.
Having reviewed the inflation data, here are the views of different Fed speakers last week.
The first was Atlanta Fed President Raphael Bostic, who is a voting member of the FOMC this year. Bostic, a hawk, re-affirmed his view that he expects only one rate cut in 2024. If Powell wants a decision with no dissents for a June rate cut, Powell will be challenged to persuade Bostic to cut rates in June.
Fed Governor Lisa Cook gave a more balanced view and she is probably in the June cut camp. She affirmed that, “The risks to achieving our inflation and employment goals are moving into better balance.” Easing too soon “could allow above-target inflation to become entrenched”, but easing too late “could also do unnecessary harm by holding back the economy and depriving people of economic opportunities”.
Fed Governor Christopher Waller’s
speech reiterated his conviction that there’s no rush to cut rates: “In the absence of an unexpected and material deterioration in the economy, I am going to need to see at least a couple months of better inflation data before I have enough confidence that beginning to cut rates will keep the economy on a path to 2 percent inflation.” More importantly, Waller has moved to the two or less rate cut camp for 2024. “In my view, it is appropriate to reduce the overall number of rate cuts or push them further into the future in response to the recent data.”
Since the Fed targets headline PCE, the latest report shows downward progress appears to be stalling. The data is inconsistent with Waller’s criteria of “at least a couple of months of better inflation data”.
On Friday, Powell participated in a discussion at the Macroeconomics and Monetary Policy Conference in San Francisco after the release of the February PCE report. He said that the February report was in line with expectations and “definitely more along lines of what we want to see”. However, the economy is strong and there is no hurry to cut rates, but added unexpected weakness in the labour market would draw a policy response.
In summary, Fed speakers last week show growing evidence of a hawkish voting bloc within the FOMC that would dissent to a cutting cycle which begins soon in the absence of significant deterioration in the economy. Fed governor Waller and Atlanta Fed President Bostic made their hawkish views clear. While Richmond Fed President Barkin and Fed Governor Bowman made no speeches last week, they are also well-known hawks who form part of that bloc. Engineering a June rate cut under those circumstances will be a significant challenge for Chair Powell.
The dovish case
Even as FOMC members turn more hawkish, here are some reasons why opinion takes a more dovish turn.
Powell gave a hint of this at the press conference. When questioned about the timing of a rate cut, he said that the Fed takes decisions meeting by meeting, and they don’t see any reason for a cut in March. However, “things can happen during an inter-meeting period if you look back…[While] we don’t see this in the data right now, but if there were a significant weakening in the data, particularly in the labour market, that could also be a reason for us to begin the process of reducing rates again”.
In other words, Powell opened the door to faster rate cuts should the job market weaken. And leading indicators of employment are forecasting a marked deceleration in nonfarm payroll employment.
Even though the history of these indicators is limited, temporary jobs (blue line) and the quits/layoffs ratio (red line) lead nonfarm payroll employment (black line). Both indicators peaked in Q2 2022 and they have been deteriorating ever since.
The Kansas City Fed Labour Market Conditions Index also has a track record of being a leading indicator of employment. This index plateaued in H1 2022 and has been falling ever since.
Although former Fed economist Claudia Sahm wrote in a Bloomberg OpEd that her Sahm Rule is designed to be aggregated nationally to spot recessions in real time and there’s no such as thing as a state Sham Rule, UBS pointed out that 20 states have triggered the Sahm recession rule. Does that count as a “significant weakening” in the labour market data?
In connection with analysis of the labour market, wage inflation has been cited as a possible concern as an impediment to rate cuts. I disagree. Labour market productivity has been rising at an above trend rate, which allows for better wage gains by workers.
In fact, the annual changes of productivity-adjusted compensation, as measured by the annual changes in Employment Cost Index, which measures total compensation including benefits, less productivity gains are coming in well under core CPI.
Fed watchers should scrutinize labour market data as closely as inflation reports.
In addition, Powell was asked at the press conference about financial conditions. Powell appeared unconcerned: “There are many different financial conditions indicators and you can kind of see different answers to that question. But ultimately, we do think that financial conditions are weighing on economic activity”.
Here is what he probably means. The Fed unveiled a new
Financial Conditions Index, called FCI-G. FCI-G “aggregates changes in seven financial variables — the federal funds rate, the 10-year Treasury yield, the 30-year fixed mortgage rate, the triple-B corporate bond yield, the Dow Jones total stock market index, the Zillow house price index, and the nominal broad dollar index—using weights implied by the FRB/US model and other models in use at the Federal Reserve Board”.
The accompanying chart shows the analysis of FCI-G to May 2023, with higher values denoting tight financial conditions.
The updated FCI-G chart to February 2024 shows that financial conditions are loosening, but they are still tight by absolute standards. That’s why the Fed isn’t overly worried about loose financial conditions, which is mainly evident in stock prices.
In conclusion, I believe the market hasn’t discounted Powell’s political need for unanimity for the first decision to cut rates in an election year. Brace for disappointment as market expectations shift to a higher-for-longer narrative.
Current consensus expectations call for the first quarter-point rate cut at the June FOMC meeting, which is probably a stretch for FOMC members. Fed Chair Powell needs to form a consensus for a politically sensitive rate cut decision during an election year He can’t afford a dissenting vote in order to present a united front by the Fed. A number of voting members have already voiced reservations about the speed and number of 2024 rate cuts last week. It will be difficult to form a consensus for a June cut in the absence of either lower inflation data or weakness in the labour market.
