Inevitably Hawkish
Doug Walters
The Fed Chairman struck a decidedly hawkish tone this week. In this week’s edition, we talk about why the Fed needs to keep expectations in check despite notable signs of improvements in inflation.
Contributed by Doug Walters , David Lemire , Max Berkovich , Eh Ka Paw
The Fed Chairman was hawkish in his Jackson Hole speech on Friday, which was an inevitable outcome. He set clear expectations for continued significant rate hikes in the months to come. Expectations drive behavior in economics, and it was important for Powell not to let sentiment turn too optimistic.
It may seem counterintuitive, but The Fed does not want to see investor optimism right now. In the fight against inflation, positive expectations can be the enemy. If investors believe The Fed will slow or stop raising rates because of recent gains against inflation, the result would likely be rising asset prices. Stocks, bonds, and real estate could all benefit. Rising wealth would lead to rising demand for goods, putting upward pressure on inflation.
In that lens, the tone of the Chairman was unsurprising. He needs to keep expectations in check until we have indeed turned the corner on inflation. Allowing sentiment to shift dovish too soon could reverse any gains made on inflation. That is a lesson learned the hard way in the 70s and 80’s when The Fed tried to strike a much more nuanced monetary balance. For now, expect The Fed to maintain steadfast in its hawkish leaning even as we see inflation moderating.
Core PCE inflation fell again this month
As measured by the PCE deflator, inflation is still relatively high but has fallen from its February peak of 5.3%.
Headline of the Week
The Fed Chairman’s speech at Jackson Hole was the week’s most significant headline. The brief speech (one of the shortest by a Fed Chair) left its mark on equities, with the S&P 500 down 4% on the week. But we would be remiss not to take a moment to highlight the latest US inflation number, the PCE deflator.
- The PCE deflator historically has been the Fed’s preferred measure of inflation.
- On Friday, the data release showed core inflation falling from 4.8% year-on-year to 4.6% in July. That is down from a peak of 5.3% in February.
- The headline (non-core) number was higher at 6.3%, down from 6.8% in June.
So inflation is coming down, but certainly not enough yet to justify any significant change in Fed policy. We will have to wait another three weeks for the next big inflation release. Until then, we will turn our focus to jobs.
The Week Ahead
As summer draws to an unofficial close, the nation’s economists remain hunched over their spreadsheets, cranking out reports.
- Everything builds to next week’s Nonfarm Payrolls report (aka the JOBS number). Consensus is calling for some cooling from July’s strength. Despite an uptick in layoff announcements, it is still a favorable market for job seekers.
- The opening act(s) for Friday’s Jobs report is the ADP Employment Survey on Wednesday and the JOLTS Job Openings report on Tuesday. How the market interprets this trifecta is always an open question.
- And most importantly, Business Park Drive will see a flurry of economic activity as the final preparations are completed for Strategic’s return to the office. Anyone who missed it, check out Alan’s August Rundown for a great before/after screenshot. We look forward to welcoming clients and colleagues for some old fashion “facetime.”
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