Still on vacation, probably about to leave cell service, so quickly today…
Federal Reserve Chair Jerome Policy delivered his widely-anticipated speech at the Fed’s annual Jackson Hole conference and left intact expectations that the Fed would ease at the upcoming September FOMC meeting. Importantly, Powell acknowledged that the Fed was in uncharted waters here:
We have much experience in addressing typical macroeconomic developments under this framework. But fitting trade policy uncertainty into this framework is a new challenge. Setting trade policy is the business of Congress and the Administration, not that of the Fed. Our assignment is to use monetary policy to foster our statutory goals. In principle, anything that affects the outlook for employment and inflation could also affect the appropriate stance of monetary policy, and that could include uncertainty about trade policy. There are, however, no recent precedents to guide any policy response to the current situation. Moreover, while monetary policy is a powerful tool that works to support consumer spending, business investment, and public confidence, it cannot provide a settled rulebook for international trade. We can, however, try to look through what may be passing events, focus on how trade developments are affecting the outlook, and adjust policy to promote our objectives.
There is little precedent for what currently faces the economy. Typically, fiscal policy makers only need to be slapped down once by the markets before they abandon obvious policy mistakes. Think how market participants reacted to the initial failure of TARP to make its way out of Congress. President Trump, however, repeatedly doubles-down on bad policy, leading the nation into a full blown trade war with China. Moreover, it doesn’t look like this is ending anytime soon. China retaliated last Friday, Trump retaliated again and then, after first seeming to express second thoughts, directed aides to say the second thoughts were only about the magnitude of the retaliation. He thought he should have done more.
The policy uncertainty, which includes ordering U.S. firms to stop doing business with China and calling Powell an enemy of the people, will most likely continue to weigh on investor and business confidence.
Realistically, the Fed has only one primary tool in the near term with which to respond to the ongoing uncertainty and its negative impacts on financial markets directly and the economy in general: Rate cuts. There is no other path forward here; if the economy is in a good place as the Fed believes, and the risks both real and hypothesized are primarily on the downside, the Fed will cut rates until they have stabilized the situation.
How many rate cuts will that require? Of course we don’t know. What we do know is that market participants know that one is not enough. And Powell knows that keeping financial conditions accommodative is partly about meeting financial market expectations:
Committee participants have generally reacted to these developments and the risks they pose by shifting down their projections of the appropriate federal funds rate path. Along with July’s rate cut, the shifts in the anticipated path of policy have eased financial conditions and help explain why the outlook for inflation and employment remains largely favorable.
Powell made no effort to shift expectations that the Fed would cut rates in September and in the process essentially nullified any of the hawkish noise coming from some of the regional Fed Presidents. I think Powell pretty much understands the situation and appropriate policy path.
Bottom Line: Powell and his colleagues are working to offset the direct risks to Main Street from sagging business confidence and the indirect risks from Wall Street turbulence spilling over onto Main Street. This means further rate cuts. We don’t know how many because we haven’t faced a situation where fiscal policy makers just will not take the hint. More than one, hopefully not so many that we are back to the zero bound.