Powell Is Giving the Market What It Wants, Not What It Needs

Federal Reserve Chair Jerome Powell at the Jackson Hole Economic Policy Symposium in Wyoming. (David Paul Morris/Bloomberg)

Federal Reserve Chair Jerome Powell said on Friday that the central bank would revert to its policy approach used prior to 2020. But the Fed might be better served by reaching back to its tack of more than a generation ago.

William McChesney Martin, who chaired the Fed from 1951 to 1970, famously said the role of the monetary authorities was to take away the punch bowl just as the party was really warming up.

By any measure, the markets are partying hearty, with stocks hitting records, corporate credit spreads at quarter-century lows, plus myriad signs of speculative fervor. Those include margin debt topping $1 trillion for the first time, the revival of initial public offerings (most of which have experienced big opening-day price pops), record options activity, and even the revival of special purpose acquisition companies (SPACs), or blank-check companies for the next big thing.

Those are hardly the circumstances suggesting the need for easier money.

For the moment, however, Powell’s much-anticipated keynote address to the Kansas City Fed’s annual policy confab in Jackson Hole, Wyo., delivered what financial market participants had hoped to hear: The Federal Open Market Committee is prepared to resume easing its monetary policy at its next meeting, which concludes Sept. 17. That is likely to come via a 25-basis-point (one-quarter percentage point) reduction in the federal-funds rate target range, which has remained at 4.25% to 4.50% since last December.

On Friday, Powell noted the conflicting pressures policymakers currently face. “In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside—a challenging situation.” But he clearly prioritized the latter.

While noting an historically low unemployment rate of 4.2%, weakening labor supply owing to the sharp decline in immigration, and the lack of layoffs (indicated by a low level of new claims for jobless benefits), he described the labor market as being in “a curious kind of balance that results from a marked slowing in both the supply of and demand for workers.” That, Powell said, could lead to “sharply rising layoffs and unemployment.”

In effect, the chair basically sided with the two FOMC members, Fed Gov. Christopher Waller and Vice Chair Michelle Bowman, who argued for a rate cut at the Fed’s July meeting. That decision came before the weak jobs data released on Aug. 1, which led to the ouster of the head of the Bureau of Labor Statistics.

Powell’s dovish shift pushed the probability of a 25-basis-point cut next month to near 90% on Friday, from the low 70% range a day earlier, according to the CME FedWatch site.

Futures continued to price in an additional 25-basis-point cut either at the October or the December FOMC meeting, which would put the rate in line with 3.9% year-end median midpoint of the fed-funds target range contained in the committee’s last Summary of Economic Projections released in June.

But the futures market is pricing in five cuts totaling 125 basis points, to a 3% to 3.25% range, by next July. That would be substantially below the 3.6% midpoint median from the last SEP.

Beyond the near-term tactical outlook, Powell updated the Fed’s overall policy framework, which gets reviewed every five years. Out was the so-called Flexible Average Inflation Targeting (FAIT), which essentially allowed for past shortfalls to the Fed’s 2% inflation goal to be offset by future overshoots.

In the years following the Great Financial Crisis of 2008-09, inflation continuously ran below 2% and the Fed kept rates near the zero lower bound. With the adoption of FAIT in August 2020, inflation was allowed to run above 2%. Too-easy policies—both fiscal and monetary—combined with pandemic-era supply-chain snags, sent inflation to a four-decade high over 9%. After that experience, the Fed has scuttled this “makeup” strategy.

The new policy will be quickly tested by facts on the ground. “We have an economy that is clearly benefiting from accommodating financial markets, and an excess supply of liquidity and savings,” Mizuho U.S. economists Steven Ricchiuto and Alex Pelle wrote in research note Friday. In other words, it’s an overflowing punchbowl, which the Fed apparently is ready to spike with more hooch.

Hanging heavily over all these policy discussions is the relentless barrage from the White House calling for the Fed to cut rates. The pressure campaign took a new twist this past week with allegations that Fed Gov. Lisa Cook committed mortgage fraud. President Donald Trump Friday threatened to fire her if she doesn’t resign

Cook has said she won’t be “bullied” into leaving. If she does, the president would have the opportunity of placing four loyalists on the Fed’s Board of Governors. In addition to dissenters Waller and Bowman (both of whom were appointed by Trump), Trump has nominated Stephen Miran to fill the term of recently resigned Gov. Adriana Kugler. And, of course, there’s the replacement for Powell, whose term as Fed chair ends next May, although he has the option to stay on as a governor until January 2028.

After the end of Powell’s chairmanship, the likely combination of an accommodative monetary policy to support an expansive fiscal policy could produce a higher yield on the benchmark 10-year Treasury—higher than anyone in the administration, or on Wall Street, expects.

Write to Randall W. Forsyth at randall.forsyth@barrons.com