Jerome Powell Jackson Hole Speech: Key Highlights and Implications
Jerome Powell gave a 10-minute speech at Jackson Hole, Wyoming this Friday. Due to global macroeconomic instability, the market scrutinized the speech as if it was another FOMC minutes meeting. Here are the key highlights and implications.
Going Back to Volcker
In the relatively short speech, Powell mentioned Volcker two times, even quoting him. Paul Volcker was Powell’s predecessor during the Great Inflation of 1979, serving as a case study on how to beat inflation. After 15 years of failed attempts, Volker was credited to beat the 14% inflation rate in 1980 by raising the interest rate all the way up to 19.1% a year later.
Powell used this historic example to showcase that people’s expectations normalize either low or high inflation, which frames their economic planning. Of course, in the worst-case scenario, if inflation remains high for too long, it can lead to hyperinflation, collapsing the entire economic model.
“The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched.”
To prevent that from happening, the Fed Chair emphasized the need to be persistent in monetary policy by taking “forceful and rapid steps to moderate demand”. Referencing July’s lower inflation respite of 8.5% vs. June’s 9.1%, Powell warned that a one-month decline is not a sufficient indicator.
The Fed’s Target Inflation Remains 2%
Powell emphasized that inflation must be brought down, regardless if it causes “some pain to households and businesses”. To do otherwise would be to inflict greater pain in the long run. In other words, the original 2% inflation target is still set. The monetary policy will be as restrictive as needed to make it happen.
“In current circumstances, with inflation running far above 2 percent and the labor market extremely tight, estimates of longer-run neutral are not a place to stop or pause.”
In the mid-longer term, this should increase the federal funds rate to 2.5%. However, this will depend on the incoming data relating to the relationship between supply and demand.
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Supply and Demand Inflation Drivers
In the recently published paper by Julian di Giovanni at the New York Fed, supply bottlenecks were pinned as major inflation contributors. The paper estimated that the inflation would’ve been at 6% instead of 9% without the supply bottlenecks. By NY Fed’s account, 60% of U.S. inflation over the 2019-21 period was spurred by demand, while 40% was spurred by supply-side issues that amplified demand further.
Meaning, that while the increased demand was spurred on by a $5 trillion fiscal stimulus, there is still much space left for dropping inflation by easing supply bottlenecks. In short, strong demand would still have to be reduced, while simultaneously increasing supply.
Unfortunately, the US natural gas hit a 14-year high on Monday, having risen annually by +150%. In the meantime, crude oil (WTI) has dropped to the February level at $92.37 per barrel, but this is still an annualized rise of +45%.
Interestingly, commodities that are typically perceived as inflation hedges have underperformed over the last year.
- Bitcoin: -55%
- Gold: -2%
- Silver -18%
Lastly, because of the dollar’s global reserve currency status, the Dollar Strength Index (DXY) is likely to go further up. The Fed’s tightening monetary policy makes the dollar more valuable, given that the world’s capital flows are still largely denominated in dollars.
Year-to-date, DXY has gone up by +13%, while experiencing another bump after Friday’s Jackson Hole speech.
This is especially true in the middle of Europe’s energy crisis. The loss of competitive edge is collapsing the euro, the main weighted currency in DXY. In what appears to be a controlled demolition of the EU’s economy, after it “sanctioned” Russia, the electricity cost has gone over +800% in the last two years, thanks to the EU’s gas dependency on Russia.
Because the EU’s economy is so fragile, consisting of multiple over-indebted nations with double-digit inflation, the ECB has much narrower leeway to raise interest rates as aggressively as the FED.
Market’s Reaction and New Benchmark
The Federal Reserve will meet again on September 21st to set new target rates. According to CME’s FedWatch tool, the probability for a 300-325 target rate is at 60.5%, from the present 225-250, which would be another 75 bps increase.
Correspondingly, the markets experienced more selloffs. During the day, S&P 500 went down by –2.10%, Nasdaq by -2.6%, and Bitcoin by -3.4%. In times like these, investors tend to switch to a recession investing mode.
In conclusion, it seems like Jerome Powell did not say anything new or unexpected.
Do you think the Fed will successfully navigate the demand/supply labyrinth? Let us know in the comments below.