Fed Misspeak

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Special Guest Blogger: Tim Kearney, PhD

It looks like Federal Reserve Governor Jay Powell committed a basic communication error that threw a shock into U.S. financial markets. At the Jackson Hole Symposium Powell seemed to downplay the ability of the Fed to discern in real time the “neutral” Fed funds rate (r*), i.e., the level of interest rates which neither inhibits growth nor stimulates inflation. He called for a risk management approach to monetary policy, rather than a rules-based approach; but his subsequent statement noted that the Fed could hike up to 50 basis points (bp) over neutral. While the comment raised uncertainty about his belief in neutral, his comment holds some hope as to intent: the Fed might go 50 bp above the current estimate of neutral, or it might be raising its estimate of the appropriate neutral rate. That is, higher growth might prompt a higher neutral rate than is necessary at present, suggesting that the Fed may remain accommodative for some time. It is a sentiment that I think the equity market would relish — once digested.

Since Jackson Hole, there has been pushback against the view that we cannot measure the neutral rate in real time, and neutral remains a useful concept. President Williams of the NY Fed and President Evans of the Chicago Fed both made comments implying that the Fed will not cut short its hiking cycle. Williams emphasized the existence of a neutral rate in the Wall Street Journal, noting “…our path today is getting us back to normal interest rates or neutral interest rates relatively quickly, over the next year or so.” Evans was rather hawkish, telling Reuters the Federal Open Market Committee “…could move to a slightly restrictive policy stance and, you know, probably pause at that point and see how things are going…” citing a target range above three percent. My view is that higher growth will lead to higher nominal rates, but the growth will come first. That sequencing is to the benefit of growth and risk assets over time.

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