Federal Reserve Chair Jerome Powell doesn’t care about your worries of a stock market bubble. Nor does he care about your inflation fears. What he cares about is getting people back to work, and he and his colleagues are going to hold rates near zero for as long as it takes to get that result. Learn to accept your low rate future.
As expected, the Fed held policy steady at this week’s Federal Open Market Committee meeting with both rates and the pace of asset purchases left unchanged. Via the Summary of Economic Projections, it also signaled that rates would remain at their current 0-25 basis point range through 2022. Importantly, Powell stressed in his press conference that he and his colleagues were not even thinking about when to raise interest rates. That question is simply off the table.
Indeed, it seems that for Powell, discussion of rate hikes is almost a forbidden topic. He is very clearly trying to not repeat the mistakes of the last cycle in which the Fed repeatedly issued premature predictions that policy would soon need to be tighten, either by winnowing the size of the balance sheet or raising interest rates. Powell doesn’t want to take the risk that a repeat performance would engender expectations among market participants that lead to tighter financial conditions through, for example, a rise in longer-term interests or a stronger dollar that stifles economic activity.
The reason Powell doesn’t want to entertain the notion of rate hikes (‘[w]e’re not even thinking about thinking about raising rates”) is because he has a laser-focus on recovering the jobs lost in the wake of the Covid-19 pandemic. He repeatedly emphasized that returning employment to its pre-Covid level was a primary objective. Powell is also particularly concerned about the employment losses suffered by lower income households, noting that this group didn’t see many of the benefits of the last expansion until the last couple of years when the unemployment rate fell below 4%.
Moreover, while Powell acknowledged that there would be some permanent job losses that require people to change jobs, he thought it too early to conclude that the natural rate of unemployment has risen (the implied estimate of 4.1% in the SEP was unchanged). Powell is not willing to accept that there has been permanent damage to the level of activity and is avoiding the trap of assuming structural change that becomes a self-fulfilling prophecy when the Fed sets tighter policy that anticipates a higher level of sustainable unemployment. In fact, using the example of this past recession Powell was very clear that the he saw little reason to expect low unemployment alone trigger higher inflation.
What this all means is that the Fed’s economic forecast is not that important (Powell said as much in this opening statement). The estimated values of the natural rate of unemployment are also not that important. What is important is actual outcomes.
So what outcomes would drive a policy shift? If the Fed doesn’t see meaningful and sustained improvement in the labor markets as the year progresses, they will likely attempt to boost the pace of growth with more explicit forward guidance and yield curve control. Absent inflationary pressure, they will not tighten policy until the labor market is largely healed. That probably won’t happen until unemployment is below 5%, so a long way off. And Powell won’t tighten policy on fears that the stock market is entering bubble territory. He made very clear the Fed wouldn’t “hold back” on some perception that asset prices were too high. Doing so would not be serving those the Fed was legally obligated to serve by supporting full-employment and stable prices.
That basically leaves only one reason that the Fed might push the Fed into changing policy anytime soon: A sustained rise of inflation above the Fed’s target. But with the economy operating at well above potential and core consumer price inflation negative for three consecutive months running, that seems like a fairly remote change.
Bottom Line: The Fed is making it very clear they aren’t going to budge in a tighter direction until a dramatic change happens in the economy. That seems like a fairly low-probability event at this point. The higher probably event is the threat of an anemic recovery pushes them to an easier policy stance. Rates are once again staying low even if the stock market powers forward. Get used to that divergence.