Time to Start Thinking About Thinking
The only thing more certain than Jerome Powell’s sincere insistence that he is not currently planning to raise rates is that sooner or later he will have to change his tune. If he isn’t actually moving to make money more expensive before the end of 2023 as he now insists, then investors are fundamentally misreading the strength of the current recovery. Worse, we have a problem in the United States that not even $5 trillion in government spending can solve.
In fact, if this corporate earnings season continues as strong as it started, he may even have a hard time stepping up to the microphone on Wednesday and repeating his “not thinking about thinking” mantra with a straight face. Markets may not welcome any messaging at first, but even a few bumps during the adjustment will be modest compared to the potential turbulence in a world where Fed guidance becomes marginalized.
Powell’s real challenge amid such jumpy markets is in crafting a few polished sentences that communicate the reality of the moment without scaring the children. Something like: “Yes, we see the data is gaining strength and we are in fact making plans to trim asset purchases and raise rates—at some point, as conditions warrant, with plenty of advance notice, in measured increments, and with our fingers crossed.” He could add: “This is good news.”
“Powell’s real challenge amid such jumpy markets is in crafting a few polished sentences that communicate the reality of the moment without scaring the children.”
Essentially, it’s the message many parents deliver at some point—especially as their children grow: “Yes, as we all know, there is in fact no Santa Claus.” Some might then add: “And isn’t it great you can now afford your own toys.”
Even since last month, the stream of data is harder and harder to ignore. March retail sales jumped 9.8%, initial jobless claims dropped below 600,000 for the second-consecutive week, and housing starts and consumer confidence are both soaring. Even the Fed’s own upgraded forecast last month of 6.5% already looks dated.
U.S. RETAIL SALES M/M, PERCENT
Source: Bloomberg. As of April 22, 2021.
INITIAL JOBLESS CLAIMS, SA, THOUSANDS OF PEOPLE
Source: Bloomberg. As of April 22, 2021.
Strangely, recent markets have been unimpressed by these numbers, with Treasury yields drifting lower. Perhaps valuations are just too dear or the talk of new taxes has dampened earnings expectations.
And, of course, there is a world full of worries. Yes, the risks of more contagious COVID strains are real. Yes, unemployment among women and minority groups remains too high. Yes, a lot of things could still go wrong. But if Eeyore keeps drafting the FOMC’s messaging, investors will stop paying attention.
It’s not so much that Powell and Co. risk falling behind the curve on inflation risks. In fact, they have all but admitted that they want to fall behind the curve and make certain that inflationary pressures are well-entrenched above their 2% target before doing anything that would really tighten financial conditions.
This is no small task, as the structural forces that have driven U.S. growth and inflation steadily lower in recent decades are not changed by lockdowns or vaccines. News of trade friction and supply chain worries will not undercut the forces of globalization that keep wages pressures in check. A glut of retirees in rich countries may spend more over time, but for now the world still faces a glut of savings.
The principal change on the U.S. horizon is the Biden administration’s new commitment to government investment, which has fallen from 6% of GDP (in the 1960s) to 2% today. Several trillion more dollars in hard infrastructure, research and development are precisely intended to raise long-term sustainable growth rates, but the Fed can hardly count on this now.
The real risk to Powell’s excessive caution is that investors start to tune out his messages as unrealistic posturing, leaving the FOMC only able to shape expectations through deeds and not words. This will mean exaggerated market intervention, outsized rate moves and bone-rattling market adjustments.
We should all hope, therefore, that the upcoming meetings produce a brighter, cheerier Fed Chair who signals the next economic forecast (due in June) may be higher, acknowledges the potential benefit of infrastructure investment, and provides a slightly more granular preview of the FOMC’s “thinking” in its next steps.
Powell doesn’t need to commit to specific actions or dates now. Surprise policy announcements are out of character and would clearly scare the children. He just needs to acknowledge that he sees the same data that everyone else sees and that the facts on the ground require his thinking to evolve, too.
For all his natural caution as a central banker, Powell also understands the wisdom of John Maynard Keynes on the subject: “When the facts change, I change my mind. What do you do, sir?”