Take a moment to read the short, surprisingly clear speech by Fed Governor Esther George July 12th. It contains a warning to her fellow Fed Governors. She thinks the current Fed consensus risks a major policy error by overly hasty action. Confusing temporary (pandemic and Ukraine) shocks with long-term shocks. It is also a tidy analysis of our present economic situation.
She has been around a long time and is known as a “hawk.” She was also the only Fed Governor to vote against the 75bp interest rate increase last meeting. This is not typical hawk-speak…
I find it remarkable that just four months after beginning to raise rates, there is growing discussion of recession risk, and some forecasts are predicting interest rate cuts as soon as next year. Such projections suggest to me that a rapid pace of rate increases brings about the risk of tightening policy more quickly than the economy and markets can adjust…it is unclear just how high rates will need to move in order to bring inflation down. These dynamics suggest it will be particularly important to observe how the economy is adapting to changes in monetary policy.
The bond and commodities markets see the same risk. Commodity prices are tanking. The bond market expects the Fed to be cutting rates in 2023 (meaning too-fast raises in ’22 followed by an unseemly scramble to undo the damage in ’23). The 10 year yield is pointing to slowing growth and rate cuts (going DOWN even while expectations for near-term rate cuts are going up). Market-based inflation expectations have been coming down for weeks now. So has the Cleveland Fed’s inflation expectations index.
With the evidence above, you could usually bet the Fed will follow the markets (while pretending to lead). Multiple markets are clearly signalling the tightening campaign is (or should be) getting close to its conclusion.
The risk is the Fed (or Powell) refuses to take the hint. Powell has been widely reported as desperate to protect his reputation/legacy. He wants to be remembered as a Paul Volker (“slayer of the inflation dragon!”) not an Arthur Burns (“wimp of the 70’s stagflation”).
So are we going to have a recession to protect the vanity of one man? Ms. George seems to be asking that question to nudge her fellow governors away from enabling Powell’s agenda.
The good news? Powell probably can be convinced to declare victory if inflation readings start to come down because prior, temporary shocks are, well, temporary (we can’t say “transitory” anymore). Especially if the market is telling him the alternative is an “unseemly scramble.” If Powell is that much of a egoist/politician, he’ll be tempted by the easy win.
More sympathetically, the Fed and Powell need to talk tough now to get the result they want. But some of that tough talk is, hopefully, just bluster.
Markets are usually more right than pundits, but they still might also be wrong about declining inflation. They were wrong 6 months ago when the Fed started talking about raising rates (the 10 year also went down in November/December too). Although the markets are usually more right than the Fed or the talking heads. Lots of risks and uncertainty, as always….
The speech is still worth a read in full. She does a great job of summing up “where we are and how we got here.” In particular, she clarifies just how weird and out-of-whack the whole situation is. Prior analogues are pretty useless because we’ve never seen a situation like this before. When someone starts telling you about the 70’s/80’s or (much worse) 2001 and 2008, you already know they are wrong. Navigating on a bad map using a broken compass is certain to get you lost. Navigating from common sense gives you a fighting chance.