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Reading Between the Lines: What the Next Fed Meeting On Interest Rates Could Mean For the Future

Fed Chair Jerome Powell recently delivered a keynote speech at the Federal Reserve Bank of Kansas City's Annual Economic Policy Symposium on Aug. 26. The conference took place in Jackson Hole, Wyo., for the first time in person since before the pandemic.

Powell spoke to central bankers from around the world, emphasizing that "a single month's improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down."

While his keynote was the most talked about moment of the conference, it will be another month before we hear from the fed definitively on interest rates again. The next Fed policy meeting is Sept. 20-21. Powell said their decision during that meeting will depend on the incoming data and the evolving outlook. So, in the meantime, what can we learn from Powell's remarks?

What We're Keeping an Eye On

Powell remains hawkish in the face of heightened inflation. Some thought that the Fed might back off a bit after raising rates three-quarters of a percent in its last two meetings, but he appears steadfast. "We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2%," he said.

With that in mind, we're closely watching the monthly Consumer Price Index. This index measures the average price change over time in a fixed market basket of goods and services. In June, the index hit an alarming +9.1% and fell slightly to +8.5% in July.

However, even though the index shows inflation went down in July, Powell reinforced that the improvement falls "far short" of what they need to see before we can trust that inflation is moving down. August's consumer price index is due Sept. 13. Moreover, Powell shared that, as the stance of monetary policy tightens further, it will likely become appropriate to slow the pace of increases.

Additionally, the jobs report is one of the last big data points before the upcoming meeting. The August jobs report shows a payroll increase of roughly 315,000 new jobs for the month, which exceeded the expectation of 298,000 (Source: Bloomberg). The market reaction is initially positive with the news, but could change by the open, as further evidence that the Fed is a ways off from fully achieving its objective.

The Fed is ready to keep monetary policy tighter for longer and did not offer any forward guidance or numerical markers for when they might stop hiking interest rates. "The Fed won't repeat the mistakes of the 1970s and '80s, and prematurely cut rates in its inflation," Powell advised. He emphasized the Fed's unconditional commitment to combat above-target inflation.

What Can the Fed's Move Tell Us?

There were two potential arguments in favor of the Fed's hawkish move:

  • A solid underlying economic momentum despite mixed economic data.
  • The soft July inflation reading is short of what the committee needs to see before turning more dovish.

So, what is the Fed's real long-term target for inflation? After the Federal Open Market Committee's (FOMC) July news conference, former Treasury Secretary Lawerence Summers said the Fed's long-term inflation estimate of 2% on the back of a 4.1% unemployment rate by 2024, especially in a high-inflation environment, was "highly implausible." It's essential for the Fed to accurately assess the economy's potential growth to avoid underestimating persistent inflation like in the 1970s.

Following the Jackson Hole meeting, the rate hike expectations increased marginally for 2023. Markets are pricing roughly the same peak rate of 3.50% by December 2022, and another quarter percent hike by March 2023, but others continue to envision a cut or two by the end of next year. The median of FOMC dots projects a target interest rate of 3.375% for 2024.

How Does Uncertainty Play a Role in What Powell Had to say?

Immediately following Powell's remarks, the stock market dropped in reaction. The market hates uncertainty, and the single-day selloff in the Standard & Poor's 500 index on Aug. 26 of 3.37% after the Jackson Hole Symposium—the largest since March 2020. This result was a reaction against the uncertainty of interest rate trajectory as Powell declined to provide new forward guidance. There remains considerable uncertainty about the pace of falling inflation and how the Fed will react if inflation hovers around the 3-5% range next year without tinkering with the labor market.

The U.S. economy is barely rebounding with the headwinds of persisting inflation and lackluster personal spending growth. However, the Fed views the economy's underlying momentum as still strong, with some improvements in consumer sentiments as gasoline prices fell. As a result of reduced gas prices, Americans increased retail spending in July. Additionally, we need to wait to see the impact during fall as summer travel wanes, and inflationary pressures persist. Ultimately, service-based spending, besides travel and entertainment, will need to hold up to sustain the economic rebound.

In contrast, the Labor market, especially upward wage revision, remains the bright spot in an otherwise soft-landing U.S. economy. Gross Domestic Product and Gross Domestic Income revisions and estimates suggest that the U.S. economy is slowing but still expanding where businesses have pricing power and are comfortable passing on additional costs to consumers. For the most part, corporate profits are still substantial. Moreover, the companies faced with higher prices are predisposed to raise prices than cut costs. With more revisions still to come for the data, time will tell the clear picture of the economy. However, as things stand, the economy doesn't look like it is currently in a recession.

What's Next?

For investors who've become more accustomed to ups and downs, we're not in the clear yet. The Fed Chair has done one job at Jackson Hole: signaling to markets that the Fed is serious about keeping the tight monetary policy as long as the inflation stays above the Fed's target of 2%, even though rising interest rates could derail economic activity. The markets, however, expect to hear more than just hawkish rhetoric, perhaps with a dovish undertone that the Fed would reconsider loosening its policy if the core inflation progresses near the target of 2% and if the U.S. economy enters into a recession.

With the continued pressure of inflation on the economy and the memory of the 1970s-80s, the markets will remain sensitive in the coming days. Therefore, it is vital to read between the Fed officials' comments and FOMC statements in the meantime. As for consumers, prices are likely to remain high for a while. Consumers will need to see a persistent moderation in prices to break away from the stickiness of high inflation. By the measure of the University of Michigan's changes in prices during the next five to 10 years, the inflation expectations inched below 1% above the Fed's long-term target of 2% (August reading at 2.9%, down from the 5-year high of 3.1% in June).

Watch the OneDigital blog for Markets in Focus, with our next quarterly update coming in October. And, if you want more from Saumen, read his recent post, Are We In a Recession?, for a historical perspective on interest rates and inflation.


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