Normally, the Fed chairperson testifies before the Senate and later in front of the Congress. On 22nd June, Jerome Powell completed his testimony before the Senate and the Congress testimony is scheduled for 23rd June. However, it is the Senate testimony that actual contains key insights into the thinking of the Fed.
Major takeaways from Jerome Powellâ€™s Senate testimony
Here is what manifests when you read between the lines of the Senate testimony of Jerome Powell on 22nd June.
a) One thing is clear that the Fed remains committed to bringing inflation back to the 2% level, albeit in phases. The testimony also underlines the fact that they would like to hike rates as quickly as possible, implying a lot of front loading.
b) Powell has clarified in his testimony that the Fed would continue to be data driven and no projection or estimate was cast in stone. Hence future rate increases and any reversal would be entirely dependent on the flow of key macro data.
c) In other words, Powell has clarified that the markets cannot treat either the Fed statement or the dot plot chart or even the Fedwatch probabilities as reflective. They were at best indicative and would be decided meeting by meeting.
d) Low inflation was not only essential to keep cost of production low but also to ensure that the people of the US actually enjoyed the full benefits of higher wages. Letting the higher wage benefits get frittered away by higher inflation, defeated the purpose.
e) Fed focuses on PCE (personal consumption expenditure) inflation rather than on the consumer inflation. The PCE inflation has pegged the core inflation at 4.9% for June 2022 in the direction of pushing headline inflation closer to 2% by end of 2023.
f) Powell has suggested that the inflation was likely to be aggravated by secular supply chain constraints, Russian invasion of Ukraine, China lockdowns etc. However, the good news, as emanating from the Powell testimony, was that real GDP had picked up even amidst rising inflation since consumer spending had remained strong and robust.
g) On whether rate hikes were working; early indications were positive according to Powell. The growth in fixed investments were slowing while the housing sector was softening due to high mortgage rates. Tightening of financial conditions was surely helping the US economy to balance demand and supply.
h) Powell pointed to the huge gap between strong labour demand and tepid labour supply, when labour force participation had hardly changed in 5 months. This will keep wage hikes at elevated levels and continue to push consumer demand. It also partially neutralizes the inflation battle.
i) Powell has specifically mentioned in his testimony that the Fed would continue to communicate its thinking in crystal clear terms. Because of clear communication, the financial conditions had significantly tightened as it reflected the actions taken by the Fed so far and the actions that markets were expecting the Fed to take.
j) Finally, Fed will remain flexible enough to adapt to the changed conditions at short notice. For now, inflation has hardened more than expected, so the Fed was focussing on front loading its tightening measures. However, this could transform quickly if the signals are of a slowing economy.
The gist of the testimony was that the US economy was strong enough to handle tighter monetary policy without sacrificing growth. However, â€œSoft Landingâ€ has always been a great idea on paper, but rarely works in practice.
Have the tools and the resolve too
In any big macroeconomic battle, addressing the problem is not just about having the tools and the strategies but also the intent and the resolve to stick to a tough path. That was the overarching message of Jerome Powell in his Senate testimony. Powell summed it up best, â€œWe are strongly committed to bringing inflation down, and we are moving expeditiously. We have the tools we need and the resolve it will take to restore price stabilityâ€.
Here is the macroeconomic backdrop to the Fed approach on this subject.
Â· Inflation was sharply above the Fedâ€™s longer-term goal of 2%. For April 2022, the PCE inflation stood at 6.3% while the core PCE inflation stood at 4.9%. According to Powell, the broad basing of inflation in the last few months was due to the Ukraine war, which led to a surge in the price of crude oil. Due to its strong externalities, this resulted in inflation across manufacturing and services.
Â· Fed has already abandoned the use of the word â€œTransitoryâ€ to describe inflation hinting that lofty oil prices and the COVID-related lockdowns in China could only exacerbate the ongoing supply chain disruptions. The US being a net importer with a huge trade deficit, faces heavy imported inflation.
Â· There are two issues about growth; rather contrasting. Real GDP growth picked up this quarter as consumption spending remaining strong. Growth in fixed investment is slowing and activity in the housing sector softening due to higher mortgage rates. Hopefully, the tightening in financial conditions should temper growth and help bring demand into better balance with supply; without disrupting long term growth cycles.
Amidst all this chaos and diverse pulls, the labour market continues to remain robust.
Need for an adaptive monetary policy
Powell highlighted that the current situation was a battle of imponderables. Fed had to tighten without disrupting its goal of maximum employment. High inflation is already putting strain on vulnerable sections of society and tightening may be worsening it. Therefore, Powell has spoken about an adaptive monetary policy.
An adaptive policy may be tough in the short term but tries to ensure a soft landing in the medium term. It also has goal of fostering maximum employment and sustaining growth, while trying to control inflation. The idea of an adaptive policy is to keep the approach flexible, ready to modify at short notice and with equal aggression in the other direction. As Powell summed up, monetary policy outcomes rarely evolve the way you want it to.
To capture the gist of Powellâ€™s adaptive thrust, it is a choice between the giraffe and the dinosaur. The one that adapted better survived.