Who Can We Believe, the Fed Chairman or the CEOs of Coca-Cola, Procter & Gamble, General Mills, J.M. Smucker, Unilever, Campbell Soups, Shake Shack, Chipotle?

Jay Powell did it. The Fed chairman has been trying to figure out how to warn investors that he can’t keep interest rates at zero forever, or continue indefinitely buying $120 billion of assets every month to pump more paper cash into the economy. Last week he issued just such a warning, without conceding to his critics that his refusal to react to current inflationary pressures was a policy failure for which the economy would eventually pay dear. Investors, or perhaps only traders, foreseeing the  horrors of an economy not supported by artificially low interest rates and overactive printing presses, were rattled, with value stocks and commodities pummeled.

He Must Follow Them For He Is Their Leader

In a sense, Powell was catching up with his colleagues, who have been thinking about thinking about tightening. Many Fed officials, including Fed vice-chair Randal Quarles, have called for, as Quarles put it, “discussing our plans to adjust the pace of asset purchases”, especially if growth, employment and inflation “come in stronger than I expect.” Former Fed vice-chairman Donald Kohn says of the current inflation, “It’s got my inflation antenna quivering.” In June, 13 of 18 Fed officials – up from only 5 in March – said inflation is more likely to turn out higher than their forecast rather than lower.  And James Bullard, president of the St. Louis Fed and set to join the Fed’s policymaking committee next year, set markets quivering on Friday by telling a CNBC audience that there is “more inflation than we were expecting …. I think it’s natural that we’ve tilted a bit more hawkish here to contain inflationary pressures”. Bullard echoed several colleagues by predicting tightening would begin late next year, rather than in 2023 as the Fed expected only a few months ago.

Good News For Us, Disturbing For The Fed

Powell admitted that the economy is growing more rapidly and sooner than the Fed gurus had anticipated. They now expect GDP to grow by 7% this year – an increase from the Fed’s earlier 6.5% forecast -- “its fastest rate of increase in decades” according to Powell. He says that the Labour market is “very, very strong looking two years out”, and is now stronger than Fed forecasters thought it would be at this point. But he estimates that employment remains 8.4 million jobs below the pre-pandemic level, which Treasury Secretary Janet Yellen believes is due in part to the fact that 2.6 million workers have retired and are not likely to return to the job market, some, I guess, because they have benefited from the spurt in share and house prices during the pandemic. Meanwhile, 9.3 million job openings remain unfilled, and quit rates by confident workers are at record levels.

In this red hot economy, with product shortages and wages rising, it is no surprise that inflation is moving up. The Fed, revising an earlier forecast of 2.4%, now guesses that its preferred measure will jump to 3.4% in the fourth quarter, but continues to regard that increase and the 5% rise in consumer prices as transitory while the supply side of the economy adjusts to the sudden increase in demand, now likely to accelerate with New York and California unlocking economies that account for almost one-fourth of the nation’s GDP.

A Chairman Shaken But Not Stirred to Act

So Powell is not prepared to abandon the Fed’s highly accommodative – “loose” in lay language – policy. Interest rates remain at zero – negative, if inflation is taken into account. The Fed will continue to purchase $40 billion in mortgage-backed securities to back a housing industry that Powell says is “strong”, and $80 billion in treasury bonds to pump cash into an economy in which “household spending is rising at a rapid rate ... and business investment is strong.” Larry Summers, Bill Clinton’s Treasury Secretary, believes “Future financial historians will be mystified by why we are spending $50 billion a month buying mortgage-backed securities [to boost the housing market] in the face of a housing price explosion.”

Perhaps less mystified if they understand that a roaring macroeconomy with full employment as that term has long been understood no longer is the metric to which Powell repairs. The chairman’s new definition of full employment is a situation in which “those least able to bear the burden” of the pandemic “… lower-wage workers in the service sector and ... African Americans and  Hispanics,” become about as well off compared with the majority as they were before the pandemic. “We view maximum employment as a broad-based and inclusive goal.”

Until now, Fed policy has favored the better-off: low interest rates drive up the value of assets such as shares and houses, while jobs were not easy to come by for some groups. He now wants to give those hardest-hit groups an opportunity to cash in on the recovery by keeping the economy and the job market superheated. But without triggering a rise not only in inflation or, more dangerously, in inflationary expectations. No easy trick.

Powell Goes To the Mountains

The question is no longer whether the Fed will tighten, but when. On August 26-28 Powell will gather in Jackson Hole, Wyoming, with the world’s central bankers to discuss “Macroeconomic Policy in an Uneven Economy.” With the November 2022 elections still more than a year away, he could not reasonably be accused of playing politics were he to announce that the Fed will be rolling back its asset purchases. He has already prepared markets for just such a move, so a major sell-off and collapse in share prices is unlikely. At least here in the U.S.

But some of his international counterparts, aware that when America raises interest rates the dollars they need will be more expensive, and that they might have to follow the Fed even if their economies are not growing, have brought along their rune stones and can be expected to pay close attention to the Fed chairman’s language, both oral and body. “The dollar is our currency, but it is your problem,” then Treasury Secretary John Connally told astonished G-10 colleagues in Rome fifty years ago. Still true.

It is, of course, possible that Powell, perhaps still a bit shell-shocked by his participation in what in retrospect might reasonably be thought premature tightenings in 2013, 2015 and 2018, will persist in his belief that inflation is transitory, that his March guess that rates can remain on hold until 2023 remains the best guess. Critics are not so sure. Disrupted supply chains cannot be relinked overnight. Semiconductor fabrication plants cannot be constructed in a year. Rising wages will eat into margins and force price increases at restaurants, hotels and firms from General Mills and Unilever to the local pizzeria.  Workers are demanding flexible schedules, which raise costs and eventually prices, quit at record rates if unhappy, and are unlikely to tolerate a reversal of recent pay rises. If those higher wages are built into further price increases, we would have an inflationary spiral. If Powell clings to his present view, he just might be mugged by these realities. 

Unless his colleagues do him in first. Some 14 Fedocrats are due to give speeches this week. They can be expected to reassure markets, some smoothly, some ham-handedly, some inflation hawks aiming to force a tightening now.