Jerome Powell brings a new style to Fed

 

Chief Economist, Matthew Peter 

 

This week, the world’s two most powerful central banks, the US Federal Reserve (Fed) and the European Central Bank (ECB), held their (roughly) monthly meetings to determine monetary policy for the US and euro area, respectively. The Fed decision, to lift the target band for the fed funds rate by 25 basis points (bps), was entirely anticipated by the market.

The ECB’s decision to end their asset purchase program by December 2018 was also anticipated by markets. However, in a surprise move, the ECB announced the timing of the first increase in their target interest rates deposit rate would be unlikely until after the (European) summer of 2019; some months later than the market had been expecting.

In our view, a more pragmatic approach to the setting of monetary policy is emerging in both the Fed and the ECB. A more pragmatic approach has been forced on the ECB by political developments in Italy and a recent loss of momentum in the euro area economy. For the Fed, where economic growth is increasing, there are different factors at play. The rate increase by the Fed continues the strategy of gradual normalisation of interest rates, kicked off during the tenure of Chair Yellen, and it is tempting to assume that Chair Yellen’s successor, Jerome Powell, is maintaining the status quo.

In our opinion, Chair Powell is moving the Fed in a different direction to that of the Yellen era. The difference is a move to a more pragmatic approach, away from a more strategic approach under Yellen. The difference is apparent in the style of communication. Chair Powell opened his press conference following the FOMC meeting by stating that he was first going to provide a “plain English summary” as monetary policy “affects everyone”, not (presumably) just financial markets and the financial press, who constitute the bulk of those present at the press conference. This was a clear point of differentiation from Dr Yellen, whose more technical approach was arguably less accessible to the general public.

In addition, he delivered a very simple message to his broader audience: that the US economy is in great shape. In this regard, Chair Powell is in the mould of President Trump; talking directly to and delivering straight-forward messages to his constituency, rather than the institution’s perceived constituency. In addition, Chair Powell delivered a very simple message to his broader audience: that the US economy is in great shape. In this regard, Chair Powell is in the mould of President Trump; talking directly to and delivering straight-forward messages in the vernacular of his constituency. However, more important to financial markets than delivery style is content.

What we found revealing was how Chair Powell dealt with the Q&A session that followed his prepared remarks; particularly his responses to questions around the “dot plots” – the Fed’s guidance to fed fund rate settings over the coming three years. Here, Chair Powell refused to be drawn into a detailed discussion on the fed funds rate forecasts of his Reserve Bank Presidents, preferring to bat away questions with references to the inherent uncertainty around forecasts and reiterating that the Fed was not wedded to a particular view.

Chair Powell indicated that the Fed would be ready to move policy quickly in line with how the economy was unfolding. While Dr Yellen was also careful to signal that the Fed would not ignore the way in which the economy was evolving, she was more willing to justify and explain strategic targets such as the longer term, or neutral, rate projection.

In contrast, chair Powell appears to downplaying the “dot plots” and in so doing, is downplaying the importance of this aspect of strategic market guidance that has been a central aspect of Fed policy making and market communication since its introduction by then Chair Bernanke in 2012. A move towards a more data-driven, short term approach to monetary policy by the Fed will be a challenge for financial markets that have been weaned on a very steady and strategic approach in the years of Dr Yellen’s incumbency.

Will Chair Powell allow the Fed monetary policy to become hostage to fluctuations in short term economic data? One wonders what Chair Powell’s approach would have been during the sharp, but temporary, fall in inflation that occurred in the US around this time last year and the swift recovery in growth and inflation that followed.

At the moment, the US economy is calm and buoyant, and monetary policy can continue on its expected path given by the Fed dot plots of another two 25bp rate hikes this year and three 25bp hikes next year. However, beware any stumble in the trajectory of US growth and inflation, and don’t expect to rely on guidance from the Fed dot plots for too much longer.

 

Table 1: Financial market movements, 7 – 14 June 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,782.5

0.4%

US

2.94%

1.5 bps

US Dollar Index (DXY)

94.88

1.5%

Nikkei 225

22,738.6

-0.4%

Japan

0.04%

-1.2 bps

USD-JPY

110.63

0.8%

FTSE 100

7,765.8

0.8%

UK

1.33%

-6.6 bps

GBP-USD

1.326

-1.2%

DAX

13,107.1

2.3%

Germany

0.43%

-5.8 bps

EUR-USD

1.157

-2.0%

S&P/ASX 200

6,016.6

-0.7%

Australia

2.72%

-11.8 bps

AUD-USD

0.748

-1.9%

Source: Bloomberg

 

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