The Fed Has a New Attitude – September 2020
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“Runnin’ hot,
Runnin’ cold
I was runnin’ into overload
It was extreme
I took it so high, so low
So low there was nowhere to go
Like a bad dream
Somehow the wires uncrossed, the tables were turned
Never knew I had such a lesson to learn
I’m feelin’ good from my head to my shoes
Know where I’m goin’ and I know what to do
I tidied up my point of view
I got a new attitude”
Patti LaBelle singing “I’ve Got a New Attitude” from the soundtrack to “ Beverly Hills Cop” , 1984
Has this ever happened to you? You are listening intently to a presentation, trying to soak in every word. But your mind starts to drift. This happened to me listening to Jerome Powell, Chair of the Federal Reserve, during a recent press conference.[1]
Chair Powells’ prepared remarks were clear and concise. A policy shift was underway. The drift happened when reporters started asking questions.
I kept hearing the same question asked over and over and Chair Powell, remaining composed, gave the same answer over and over.
I thought “wow, how does he do it? How many times does he have to repeat his answers before they get it?” And then “I wonder what he is really thinking?”
Did the new attitude of the Fed get through?
That is when “I’ve Got a New Attitude” started playing in my head.
Listening to Chair Powell is a challenge for someone not engaged in Fed Speak. Understanding full employment and target inflation is mumbo jumbo and not intuitive to the average investor.
Without context or “assumed knowledge” (doesn’t everybody know this?) you might as well listen to Patti La Belle. Much more entertaining.
Here is my version of the lyrics with the imagined thoughts from Chair Powell:
Lyrics: “So low there was nowhere to go”
Powell: “That about sums it up for our interest rate outlook” “Rates will remain near zero”
Lyrics: “Never knew I had such a lesson to learn”
Powell: “ We are in the middle of a pandemic people! Never been here before”
Lyrics: “Know where I’m goin’ and I know what to do”
Powell: “Stick to the script, stick to the script”
Lyrics: “I tidied up my point of view. I’ve got a new attitude”
Powell: “Hope for a vaccine, a little inflation and more people working. That’s all we can do”
The last question in the press conference came from a reporter who asked:
“So what ‘s your explanation to Main Street, to average people what the Fed is trying to do here?
“And what the outcome would be for those on Main Street”
Yes, in 30 seconds or less explain monetary policy. Let’s start with inflation.
Why does the Fed want inflation?
People do know intuitively that too much inflation is not a desired outcome in any economy. Inflation happens when prices for the things you need to buy are so high you cannot afford necessities. Do I put gas in the tank or buy milk?
When the Fed talks about a 2% inflation target the “assumed knowledge” is that inflation below 2% is not enough to get the economy chugging along.
The economy is like a balloon. Literally. A balloon has to be inflated. If all the air goes out of the balloon, there isn’t much hope of becoming airborne again.
Some inflation always exists in the economy. The challenge for policy makers is the “too high or too low” scenario.
Inflation can be a positive for the economy if kept in check. What is worse for an economy is deflation. When inflation becomes deflation, there is nowhere to go.
The problem for the Fed is to achieve balance. When Chair Powell says, “ we will aim to achieve inflation moderately above 2%” he means we need to pump some air into the balloon.
Businesses need to thrive, and consumers need to spend money. Not quite there yet.
What is Maximum Employment?
Linked to the inflation outlook is the outlook for jobs. 22 million people lost their jobs at the beginning of the pandemic. About half have gone back to work. It is an improvement but there are still 11 million people out of work.
The Fed has a mandate called “maximum employment”. I would assume maximum employment means everybody is working. No one is unemployed. Unfortunately, there will always be people who are unemployed, but the question is how many.
Maximum employment is not a specific number. It is more of a range like 3.5% to 5% . At 5% it means that 95 out of 100 people are employed.
Here is the connection. If 95 out of 100 people are employed it means the economy is growing. If the economy is growing it means there is inflation on the horizon.
Let’s assume the Fed is successful. We have maximum employment and inflation slightly above 2%.
What happens next?
Interest rates have a built-in inflation component. Interest rates are built on expectations of future inflation.
If inflation is going up, expect interest rates to go up as well. Great for savers but when rates go up, the prices of bonds go down. Not great for bondholders, like me.
Chair Powell emphasized in his prepared remarks and in the Q&A the role of time. Over time, a long time, a long horizon. How long is a recovery going to take?
The long-term outlook for recovery is 2-3 years. That is a projection, a forecast, not an absolute number.
A forecast can change and given the following comment by Chair Powell :
“the outlook for the economy is extraordinarily uncertain and will depend in large part on our success in keeping the virus in check.”
Check ☑
If you are brave, you can read the transcript from his press conference on September 16th , 2020. Click the link below:
[1] Press Conference Chair Powell September 16 , 2020
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