Federal Reserve Chairman Powell will be addressing two audiences when he speaks to the high life of global banking and finance at the central bank’s annual end of summer conclave in Jackson Hole, Wyoming on Friday.
First he needs to persuade a divided Federal Open Market Committee that the conditions of US economy, the bank’s primary charge, warrant an easier interest rate policy.
Second he will try to dissuade the credit markets from their full bore assertion that the bank has embarked on a substantial rate reduction cycle.
This is a tall order for a policy pronouncement and makes Mr. Powell’s speech even more notable and interesting than usual.
The FOMC decision in July to drop the fed funds rate 0.25% for the first time since December 2008 was 8-2 with some members who approved the reduction doubting its logic or necessity. Esther George of the Federal Reserve Bank of Kansas City and Eric Rosengren of the Boston Fed voted to keep the base rate unchanged.
Ms George said in an interview with CNBC in Jackson Hole where the Kansas Fed is host, “We’ve added accommodation and it wasn’t required in my view.”
By traditional standards the US economy does not need support from the central bank. The economy expanded 2.6% in the first half, with a marginal negative adjustment to the second quarter’s 2.1% annualized rate expected on August 29th at the first revision. The Atlanta Fed’s GDPNow model is tracking at 2.2% in the current quarter.
The labor market remains steady with 193,000 and 164,000 new positions added in June and July. The three month moving average has declined from 235,000 in January to 187,000 in July but that is above new entrant level and should retain the wage and job penetration advantages of the tight labor market.
Retail sales are healthy. Last month they rose 0.7% and have averaged 0.6% from March to July. The control group figures, which inform the Bureau of Economic Analysis’ GDP calculation increased 1% in July and 0.64% each in the past five months.
The manufacturing sector has been hard hit from the trade dispute with China, Brexit and the overall slowdown in the global economy. Business investment spending has subsided and the PMI averages have moved steadily lower in the past six months. But at about 12% of US GDP manufacturing alone is not enough to tip the economy into recession.
Mr. Powell commented after the July announcement that the rate cut had aspects of an insurance policy and warned the markets against assuming it was the beginning of a reduction cycle. He later tempered that remark by noting that further rate cuts were still possible.
The logic of the Fed’s rate initiative is to keep the US expansion, in July the longest on record, on track, delivering its full employment benefits and safe from the trade dispute with China, Brexit fallout and the overall decline in global growth.
It is not clear that the FOMC is convinced that such a preventative policy requires the full weight of the central bank’s chief economic tool.
Credit markets however are convinced that the Fed has begun a complete cycle. The bond market began reducing rates in early November last year, long before the Fed’s last rate increase on December 19th.
The fed funds futures at six months--the March 18th, 2020 meeting--have just a 0.2% chance that the base rate will be unchanged at 2.00%-2.25%. The odds for at least 50 basis points in further cuts are 94% and for 75 points 68.6%.
Mr. Powell has a delicate task in Jackson Hole. He must rein in bond market expectations without generating a selloff that could send rates sharply higher with the attendant economic impact and he needs to convince Fed governors that global risks justify using more of the Fed's limited rate ammunition.
The Chairman in the past has proven adept at finding the language to reconcile disparate economic and policy perspectives.
But getting a skeptical FOMC aligned with eager bond traders without destabilizing global markets before the eyes of the financial world will be his greatest feat of legerdemain yet.
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