Jerome Powell Tries a Nuanced Fed Policy. Markets Don’t Like It.
The news conference Jerome Powell gave on Wednesday, his fourth as chairman of the Federal Reserve, was his most consequential to date, coming amid market turbulence and signs of an economic slowdown in the year ahead.
But his message — or at least the part of it that matters most for the direction of the economy and markets — wasn’t a simple one. It boils down to this:
The Fed still believes that the economy is basically sound, and that growth will continue in 2019 and beyond, albeit at a slower rate than in 2018. There were no signs that Mr. Powell and his colleagues are hitting the recession panic button presumably hidden somewhere in the Marriner S. Eccles Building.
But the choppy global economy and sell-off in stock and certain corporate debt markets has gotten Fed officials’ attention, and they’re open to the possibility that their optimism is misplaced. The officials are now thinking they should raise rates only twice next year, not three times as envisioned in September, and they’re prepared to throttle back further if events justify it.
Oh, but the effort to reduce the Fed’s multi-trillion-dollar portfolio of bonds, acquired during its post-crisis era of monetary interventionism, will continue on autopilot, no matter how much President Trump tweets his complaints about it (as he did Tuesday).
It’s a bit of a messy combination, which helps explain why stocks sold off as the news conference progressed.
Mr. Powell has emphasized that, with the economy relatively healthy, the Fed needs to make its policy moves responsive to incoming information, an approach of “data dependence.” This contrasts with his immediate predecessors, who stressed “forward guidance” — using explicit signals about future plans as a tool of policy.
“There’s a fairly high degree of uncertainty about both the path and the destination of any further increases,” Mr. Powell said in the news conference.
But the actual content of Wednesday’s announcement shows how hard it will be to abandon forward guidance in practice.
After all, Mr. Powell used a form of forward guidance — the signal about two 2019 rate increases instead of three — to indicate that the Fed is taking geopolitical concerns and strains in financial markets seriously. Had he not, the sell-off on Wall Street would have been even worse.
And the Fed’s strategy on unwinding its bond holdings in a steady, consistent manner is a form of forward guidance too — and one that Mr. Powell affirmed.
He faced an admittedly tricky task in this meeting. If he had held off on raising interest rates, it would have fueled the idea that there is a “Powell Put”— that the Fed under his leadership will act like an option contract to prevent stocks from falling too much. It would also have looked as if President Trump’s attacks on the Fed were changing its behavior.
At the same time, Mr. Powell and the Fed are plenty attuned to the possibility that market swings, especially in the price of bonds, can reveal important information about what the economic future holds.
So the use of this forward guidance was, in effect, a way for Mr. Powell to have it both ways: to keep on the path of tighter money while signaling that the Fed will back off if market turbulence starts to really pinch the economy.
Indeed, the market drops over the last couple of months have, to some degree at least, aligned with the Fed’s goals. Some of the markets for corporate debt that had looked a little bubbly two months ago appear less so now.
Mr. Powell presumably didn’t want to undo those positive effects, and in discussing economic risks spoke more extensively about international economic challenges than about the strains in interest-sensitive sectors of American industry.
It may not have been enough for Wall Street on Wednesday, but there actually was some good news in the materials the Fed published for those who think the rate increase campaign should come to an end sooner rather than later.
The consensus view of Fed officials on where their interest rate target ought to end up in the longer term was lowered, to 2.8 percent from 3 percent. That implies that officials have increased comfort with finishing their rate-raising campaign before much longer.
But in figuring out whether, and when, to suspend rate increases, Mr. Powell and his colleagues face an inherent contradiction.
It’s well and good to make your policy by responding to incoming events, rather than following a preset course. But often a central bank’s most powerful tool for guiding the economy isn’t “open market operations,” the term for buying and selling securities to influence interest rates. It’s “open mouth operations,” or telling the markets what you intend to do.
It’s mighty hard to have it both ways, as Mr. Powell found on Wednesday.