At Jackson Hole, Jerome Powell calls US inflation too high

26 Aug 2023 , 08:49 AM

Over the last 40 plus years, the Jackson Hole gathering in August each year has become a forum for central bankers from across the world to put their heads together to address global economic problem. In 2023, the Jackson Hole Symposium had kicked off on August 24, 2023 and the big story everyone wanted to hear was the view of the Fed on inflation and rates. To a largely extent, Powell maintained his consistent stand that inflation was too high and that markets may have to be prepared for more rate hikes. However, there were no specifics about the time table for rate hikes, the trajectory, and the approximate terminal rates. Here is what the Powell speech at Jackson focused on.

An encore of Jackson Hole 2022

In a sense, the view was that Powell said almost the same things he had said last year at the same venue. It is just that he sounded a little more confident about growth but a little more ambivalent about the trajectory of inflation. Powell, in his speech, acknowledged the progress made by the US Federal Reserve in containing inflation, but added that the rate of inflation was still way above the levels that would make policymakers feel comfortable. Like in the previous year, Powell once again warned of some likely pain as the Fed persisted with its efforts to pull runaway inflation down to its 2% goal.

However, there was one area of difference between Powell at Jackson Hole in 2022 and in 2023. In 2022, there were still question marks over GDP growth and the fears were rife that the US economy would slip into a full-fledged recession by the second half of 2023. That has fortunately not happened as the US economy has shown a lot more resilience than expected. The difference was in the tonality. Jackson Hole 2023 was all about “proceeding carefully”. Powell admitted that the combination of falling inflation and steady GDP growthy made the rate choice a lot tougher for the Fed. After all, they had to contain inflation and inflation expectations without causing damage to the growth engine.

Fed at a tipping point in the inflation battle

In his speech at the Jackson Hole, Powell underlined that the US policymakers were at a very critical tipping point in their rate stance. For example, there was going to be no let-up in the vigilance against rising inflation and inflation expectations getting unanchored. That could call for more interest rate hikes. However, Powell underlined that one cannot lose perspective. The Fed had already raised rates by 525 basis points till date. That has taken the rates to a 22 year high, well above the neutral rates. At this stage, every 25 bps increase in rates can subdue growth, more than it can subdue inflation. However, that has not been happening now and the only reason for that was the strong labour markets in the US.

For the Fed, this tipping point comes from the very delicate tightrope that it has to walk between containing inflation and not impacting GDP growth. In these circumstances, the Fed chair was tight-lipped about two issues. Firstly, Powell did not address the issue of what would be the terminal rates of interest in the US. He has just restricted himself to saying that the Fed would not be driven by any specific number but would focus purely on data flows. Secondly, Powell has not given any indication about when the Fed would commence rate cuts in the US. The CME Fedwatch has been hinting at rate cuts from the first quarter of 2024, but if the last 1 year is anything to by, then it is the Fed leading the CME Fedwatch and not the other way round.

Inflation must move sustainably lower

While there were questions on when the Fed would relent on hawkishness, Jerome Powell has refused to give any commitment. However, he did give some broad indications in his speech at Jackson Hole. According to Powell, “Although inflation has moved down from its peak, which is a welcome development, it remains too high in absolute terms.” In his Jackson Hole speech, Powell expressed the broad Fed approach that they were prepared to raise rates further if appropriate. He also added that the Fed would continue with its restrictive policy until the Fed was confident that inflation was moving sustainably down.

For a long time, the avowed inflation goal of the Fed has been 2%. However, there are several sub-texts to this inflation goal. Firstly, the Fed does want a flash in the pan. Instead, it would focus on inflation staying subdued at around the 2% level for a prolonged period of time. Secondly, when Fed talks about inflation, it talks about PCE inflation and not about the regular consumer inflation. PCE inflation is normally announced towards the end of the month (for the previous month) and is based on personal consumption expenditure. Thirdly, Fed would not be satisfied just with a sharp fall in headline PCE inflation, unless it is also backed by a fall in core inflation too. In short, food and fuel prices falling is not enough.

Doing too little versus doing too much

As Powell put it succinctly, “We are navigating by the stars under cloudy skies.“ What do we refer to by doing too little? Here Powell is referring to getting too dovish too soon or ending up hiking rates less than warranted. According to Powell, doing too little could allow above-target inflation to become entrenched. This will also impact inflation expectations since the inflation battle in the US succeeds when the consumers believe that the Fed will take care of runaway inflation. Doing too little may eventually require monetary policy to wring more persistent inflation from the economy. This could come at a high cost to income and jobs. On the other hand, doing too much or getting too hawkish could also impact growth by making the macroeconomic and the liquidity situation tighter than warranted. 

That is where the discussion by Powell about perspective comes in handy. According to Powell, till date, the Fed had implemented 11 interest rate hikes, pushing Fed’s key interest rate to a target range of 5.25%-5.50%. This is the highest level of rates since 2001. In addition, the Fed has also trimmed its balance sheet by nearly $1 trillion and to that extent the liquidity has been curtailed in the economy. While that is not a rate hike, it works to magnify the impact of a rate hike. While Powell has given little hints of the trajectory of rates from here, the FOMC (Federal Open Markets Committee) minutes are pencilling a pause in September Fed meet, followed by a 25 bps rate hike in November 2023.

GDP growth continues to remain buoyant in the US

According to Powell, one signal of a change in the Fed stance from hawkish to neutral cold be if GDP gets actually impacted. In short, economic growth may have to slow before the Fed can change course. There are no indications as of now. In the first quarter ended March 2023, the US reported 2.4% GDP growth. For the second quarter ended June, only the first advance estimates are out and that has come in at 2%. The revisions in the second and third estimates are expected to take US GDP growth in the second quarter, at least, 30-40 bps higher. But the big positive surprise to GDP may come in the September 2023 quarter. As per the Atlanta Fed estimates, Q3 GDP growth may spike to 5.9%, which could make it a very difficult situation for the Fed to shift from hawkish to neutral in its rate stance.

That is the irony of expectations from the Fed. Even as the markets are looking at clarity from the Fed on the trajectory of rates, the Fed has other things on mind. Even as the markets await signals, the Fed itself is trying assess where they stand. The way the Fed sees the situation, the US economy has slowed to some extent, but that is not enough to make them confident that consumer inflation is going to come down. At a time when the economists are warning of a likely recession, the US growth appears to be getting stronger, In this kind of anomalous situation, it is very likely that hawkishness could persist longer. The only consolation is that Powell is open to pause for longer to let the full impact of past rate hikes sink in fully.

Time for India to reassess where it stands

What are the key takeaways for India and the RBI from the Powell speech at Jackson Hole? The speech becomes especially relevant in the light of the policy dilemma that the RBI finds itself in. The RBI has paused on rate hikes since February. While the decision appeared to be right in the beginning, the spike in inflation in the last 2 months has raised questions. If India is looking at some ideas for addressing this dichotomy, then there are some good hints available in the Powell speech at Jackson Hole.

Firstly, it has been quite evident in the US and India that rate hikes don’t really impact growth if other factors are favourable. In India, the higher interest rates were offset by higher liquidity, higher job creation and a relentless flow of capex by the government. These factors have pre-empted a slowdown in growth even as interest rates were up by 2.5%. Today, the RBI is once again in a dilemma. Inflation is again close to the April 2022 peaks, but the monetary approach still remains blissfully neutral. There seems to be an obsession about not hurting GDP growth. What we learn from the Powell speech is that it is OK to be singularly focused on inflation. Other thing swill automatically fall in place!