Global Daily – Hawkish Powell homes in on financial stability concerns

by: Bill Diviney

Fed View: Rate guidance shifts up, Powell tilts hawkish – The FOMC raised its target range for the federal funds rate by 25bp to 1.75-2.00%, as was widely expected. As had been flagged, there was a technical adjustment to the IOER rate, which was raised by 20bp instead of the usual 25bp, in order to anchor the effective fed funds rate more comfortably within the target range (see here). Chair Powell also announced that the Fed would hold a press conference at each meeting from January onwards, rather than once per quarter, something he (unsurprisingly) stressed said nothing about the future policy path. Alongside the rate rise, the FOMC’s new Summary of Economic Projections showed a median projection of two further rate hikes in 2018, for a total of four this year (previously three) – bringing the Fed into line with our own view of a 25bp hike at each quarterly meeting. The median projection for 2019 also moved up to almost – but not quite – three hikes, now a bit more than our view of two 2019 hikes. The change in the projections was not so surprising given that it was on the borderline between 3 and 4 hikes for 2018 (i.e. only one member of the FOMC needed to change their view for the median to shift a full rate hike), however we felt a change in September was more likely following the appointment of incoming Vice Chair John Clarida (who has been approved by the Banking Committee but is still awaiting final approval by the Senate).

The biggest news from today’s meeting, in our view, was Chair Powell’s surprise emphasis on financial stability in the press conference. On at least four or five occasions – and mostly unprompted – Powell appeared to elevate financial stability concerns to a level of importance similar to the Fed’s official goals of 2% inflation and maximum unemployment. Indeed, while noting that current financial stability conditions were around ‘normal’ levels overall, he expressed concerns over asset prices in ‘a couple of pockets’, and also referred to historically high corporate leverage. In his most striking remark on the topic, towards the end of the press conference, Powell pointed out that the previous two business cycles did not end because of high inflation, but because of financial instability, and that this was something Committee members should therefore ‘keep our eye on’. This emphasis suggests to us that the Fed may not necessarily need to see higher wage growth or inflation to push rates beyond neutral, but that an increase in financial stability risks alone could hold just as much weight in driving rate rises. While financial stability has always been an important focus of central banks, this is a marked change in emphasis by Chair Powell.

As expected, Chair Powell cautiously navigated questions over trade policy, only stating that business contacts had expressed concerns and relaying anecdotal reports of delayed investments. However, consistent with what we have been seeing, he pointed to little sign of this in the macro data, which has been very strong. Considerable reference was also made to the possibility that the NAIRU could well be lower in the past, perhaps because of higher education rates – an idea that first appeared in the May FOMC minutes, and something we also discussed in our recent report on inflation (see here). Finally, Chair Powell appeared to downplay concerns about the flattening in the yield curve, pointing out that it was a natural consequence of higher short-term rates, and that a lower term premium could be muddying the signal we would normally take from it.

All told, the rather hawkish tone to the press conference is consistent with our view that the Fed will continue to hike at a quarterly pace until next June, while the emphasis on financial stability suggests an evolving reaction function at the Fed that could mean additional tightening further down the line – even in the absence of an inflation overshoot. (Bill Diviney)