Last week, Federal Reserve Chairman Jerome Powell delivered his anxiously anticipated speech at the annual economic policy conference in Jackson Hole. The speech garnered attention for its hawkish tone, outlining the Federal Reserve’s commitment to combating inflation and laid out the current economic landscape, challenges and policy considerations.
Key Takeaway: The Commitment to Tackle Inflation
Jerome Powell emphasised that the Federal Reserve’s primary job is to bring inflation down to its 2% target. Over the past year, the Fed has tightened its monetary policy to address the issue. Powell signalled that they are prepared to raise interest rates further if necessary and maintain a restrictive policy until they are confident that inflation is declining sustainably.
Progress So Far: The Decline in Inflation
Initial Causes and Policy Responses
According to Powell, high inflation initially resulted from a clash between strong demand and pandemic-related supply constraints, but he failed to mention the effect of Fed’s dovish policy and exponential increase in M2 as a direct result from it. The Federal Open Market Committee responded by raising the policy rate in March 2022. This tightening was aimed at slowing down aggregate demand, giving supply time to catch up.
Current Trends
Headline inflation, represented by the Personal Consumption Expenditures (PCE), has dropped from a peak of 7% in June 2022 to 3.3% in July 2023. However, Powell warned that food and energy prices, which are influenced by volatile global factors, can provide a misleading signal about the future direction of inflation.
Core PCE Inflation
Focusing on core PCE inflation, which excludes food and energy, Powell noted that it peaked at 5.4% in February 2022 and has since declined to 4.3% in July 2023. While encouraging, Powell cautioned that this is just the beginning of a long journey toward achieving the 2% inflation goal.
Driving Factors: Breaking Down Core PCE Inflation
Goods Inflation down
Core goods inflation, particularly for durable goods like motor vehicles, has fallen sharply due to tighter monetary policy and the slow unwinding of supply and demand dislocations.
Housing Services Inflation down
Higher interest rates have caused mortgage rates to double in 2022, leading to a decline in housing starts, sales, and house price growth. Powell noted that measured housing services inflation has begun to fall as a result.
Non housing Services Inflation stable
Accounting for over half of the core PCE index, non housing services inflation has remained stable. Further progress in this sector is essential for restoring price stability.
The Economic Outlook and Risks
Economic Growth
Restrictive monetary policy is expected to lead to below-trend economic growth. However, Powell expressed concern over signs that the economy may not be cooling as expected, citing robust GDP growth and consumer spending. This means that monetary policy might have to remain restrictive for an even longer time.
Labour Market Conditions
The labour market has shown signs of rebalancing, with a gradual easing of wage pressures. However, Powell warned that any evidence of lingering tightness could warrant a monetary policy response.
Uncertainty and Risk Management
Navigating monetary policy involves managing the risks of doing too little or too much. Powell stressed the importance of agile policymaking amid uncertainties related to supply and demand dislocations and labour market dynamics.
Conclusion: A Cautious Path Forward
Jerome Powell concluded by emphasising that the Federal Reserve would proceed carefully, making policy decisions based on comprehensive data and the evolving economic outlook. The ultimate goal is to restore price stability, a critical element in achieving the goal of Fed’s mandate.
This speech reaffirms the Federal Reserve’s commitment to tackling inflation while acknowledging the challenges and uncertainties that lie ahead.
The odds for a hike in September are currently sitting at 20% and 46% for November according to CME.
Ivailo Chaushev
Chief Market Analyst at Deltastock
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