Wolf Street on the Fed

Powell Explains Just How Hawkish the Fed is Getting

“But we’re a long way from neutral at this point.”

When asked how much he worried about another “financial crash,” Fed Chairman Jerome Powell told PBS News Hour that the “next set of problems” wouldn’t “look a lot like the last set of problems we had.” It would be “something else, a cyber-attack, some type of global event.” And then he threw in the zinger: “Or maybe it will surprise us and look exactly like the last one.”

It’s those zingers that deviate from the official script that make his Q&A sessions so revealing – I assume, purposefully so. And he pointed out just how hawkish the Fed is getting in its “very gradual” manner.

The interview was wide-ranging and triggered laughter in the audience on several occasions, a feat for Fed Chairs, but I’ll focus on what he said concerning risks and interest rates.

It got started with a question about the risks of raising rates too quickly or too slowly. In the latter case, the risk, he said, is that “the economy overheats, and that can show up in form of too high inflation or financial market imbalances.”

The mantra of “financial market imbalances” started showing up in Janet Yellen’s answers when she was still Chair. It’s the concept that inflated asset prices pose a risk to the financial system when those assets are used as collateral. After spending years trying to inflate those asset prices via its radical monetary policy, the Fed has been trying to tamp down on them. And it’s up there on the worry list: Powell mentioned this risk on an equal basis with “too high inflation.”

So investors shouldn’t expect the Fed to step in when asset prices sink: Bringing asset prices down some is part of the plan. It starts with bonds – raising rates has that effect on them. And it eventually goes from there.

How far will the rate-hike cycle go?

“The really extraordinarily accommodative low interest rates that we needed when the economy was quite weak, we don’t need those anymore,” he said. “They’re not appropriate anymore. We need interest rates to be very gradually moving back toward normal.”

“And that’s what we’ve been doing now for basically three years, and interest rates have just now in real terms [adjusted for inflation] moved above zero,” he said.

“Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral – not that they’ll be restraining the economy.”

“We may go past neutral,” he added, then threw in another zinger: “But we’re a long way from neutral at this point, probably.”

Currently, the Fed’s target for the federal funds rate is a range between 2% and 2.25%. To Powell, this is “a long way from neutral.” No one knows where exactly “neutral” is, and there isn’t even any agreement if the concept matters. But we’re “a long way from it,” and then the Fed may raise rates “past neutral.” This math takes short-term rates well past 3% and perhaps closer to 4%.

When asked which of the risks worry him more, “going too slowly or going too fast,” he said:

“Almost by definition, I see them as balanced…. We have to take both of those risks very seriously and try to navigate in between them.”

“We’re always going to be looking carefully at incoming data to adjust our policy. If we see things getting stronger and stronger, or inflation moving up, then we might move a little quicker. And if we see the economy weakening or inflation moving down we might move a little more slowly.”

So if the economy weakens, the Fed would still increase rates, only a “little more slowly,” and there was not a word about actually cutting rates if the economy slows. In other words, rate cuts are off the table. What’s on the table is the speed of rate increases.

Which expands on his zinger-rich comments during the press conferenceafter the FOMC meeting.

And when asked what keeps him up at night, he quipped, “basically everything.” Into the laughter, he added, “Nobody wants a central banker who sleeps well, right? What good is that?” Which led to the next and very serious question: Does he worry about another “financial crash?”

“My guess is the next set of problems we have won’t look a lot like the last set of problems we had,” he said. That the Financial Crisis won’t repeat itself for numerous well-established reasons has by now become another mantra, including chez yours truly.

“We don’t detect measures of financial instability as being elevated at this time,” he said. “They’re sort of in the moderate range, in our view, in the view of our staff, and certainly in my view. So it’ll be something else, a cyber-attack, or some type of global event. Those are the kinds of things,” he said.

And then, on second thought, he added: “Or maybe it will surprise us and look exactly like the last one.”

So, OK.

During the last FOMC press conference, Powell had warned that the US is “on an unsustainable fiscal path, there’s no hiding from it.” A few days later, the fiscal year ended, and despite the boom times, this happened… US Gross National Debt Jumps by $1.27 Trillion in Fiscal 2018, Hits $21.5 Trillion
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