Update: Stocks are moving higher on a line from Powell’s speech, which has revived hopes that the Fed could announce a decision to slow or stop its balance sheet runoff as soon as March.
“…We will continue to use our administered rates to control the policy rate, with an ample supply of reserves so that active management of reserves is not required. Having made this decision, the Committee can now evaluate the appropriate timing and approach for the end of balance sheet runoff.”
The Dow jumped 30 points on the headline…
Though, in our estimation, Powell’s remarks aren’t the only reason for bullishness.
In what will be his third round of Congressional testimony since becoming chairman of the Federal Reserve – and the first since completing what was a rocky first year at the helm of the world’s most powerful central bank – Jerome Powell will appear before the Senate Banking Committee to deliver testimony and answer questions from lawmakers beginning at 9:45 am ET.
The testimony is also the first since Powell led a market-pumping capitulation on the central bank’s plans to raise interest rates and shed its massive, QE-inflated balance sheet, cautioning during the Fed’s January meeting that the FOMC would be
Powell emphasized that the central bank would be “patient” as it “determines what future adjustments to the target range for the Fed funds rate” should be made “in light of global economic and financial developments.” That was followed last week by minutes from the meeting which revealed that “almost all” Fed officials wanted a plan to stop reducing the balance sheet by year end.
The result has been a blistering rally that sent the S&P 500 back above 2,800 on Monday, and interest-rate futures markets pricing in a rate cut before the end of the year.
Powell’s testimony also comes against the backdrop of rapidly weakening US economic data, with a raft of data released Tuesday indicating that the housing market is falling off a cliff. The Fed warned in its monetary policy report (which Powell is technically there to discuss) – that Q4 GDP could be weaker than expected.
As the dissonance between the market rally and the deteriorating underlying economic picture intensifies, analysts from Deutsche Bank noted that traders will be watching to see if Powell maintains the dovish tone that he adopted following the Fed’s December meeting, when his now-infamous remark that the Fed’s balance sheet runoff was on “autopilot” sent stocks reeling. The team at DB expects “patience” will remain the order of the day.
Mr. Powell keep the recent dovish Fed momentum going when he delivers his semi-annual Humphrey Hawkins testimony before the Senate Banking Committee at 3pm GMT today? In terms of what to look for, our US economists expect Powell to reiterate that “patience” remains the order of the day and in this regard, the January FOMC meeting minutes should be a good template for his prepared remarks. The minutes indicated “a patient posture would allow time for a clearer picture of the international trade policy situation and the state of the global economy to emerge and, in particular, could allow policymakers to reach a firmer judgment about the extent and persistence of the economic slowdown in Europe and China.” In short, our colleagues expect the Chair to convey the message that the Fed is cautiously optimistic about the outlook but will be monitoring conditions and would be willing to adapt as the uncertainties realise.
As the WSJ pointed out, a lot has changed since Powell’s last round of Congressional testimony in July. Back then, the economy was in the middle of a robust expansion, and President Trump had yet to begin attacking his Fed chair for having the audacity to even consider raising interest rates with Trump in the Oval. Lawmakers, WSJ said, will likely focus their questions on “policy, the economy, financial regulation and other topics”. Though the committee is controlled by Republicans, we imagine Elizabeth Warren will take a few moments to grill Powell about what the Fed is doing to hold big banks (like, say, Wells Fargo) accountable.
Here’s a breakdown of what to look out for, courtesy of WSJ.
Fed officials raised rates in September and December, but this year have put further increases on hold until they can better judge the effects of economic risks.
Weaker global growth in Europe and Asia, trade tensions and other political uncertainties, and market turmoil that accelerated late last year are all headwinds that could cause the U.S. economy to slow more than officials already anticipate.
Minutes from the Fed’s Jan. 29-30 policy meeting suggest more officials are particularly focused on whether inflation pressures will overcome the dampening effects of weaker demand abroad, a stronger dollar and oil price declines.
Some officials still expect the Fed will have to raise rates later this year, but Mr. Powell hasn’t indicated how high a bar he sees for another increase.
For years, the Fed raised rates under the view that a falling unemployment rate reflected declining slack across the economy that would ultimately yield stronger price pressures. This required the Fed to raise rates pre-emptively to keep a lid on inflation, even though it was holding below its 2% target.
Some officials have indicated they see little need to raise rates absent stronger signs of inflation. Others have argued they think rates are still low enough to spur growth, and that the models that have guided the Fed shouldn’t be completely set aside.
Fed officials are embarking on a monthslong review of how they meet their goals to maximize employment and maintain stable prices, which they define as 2% inflation.
Last year, Fed officials began to project a modest overshoot of the 2% goal, but this hasn’t materialized. Some officials have called for revising how they define the target to prevent expectations of future inflation from drifting lower.
Mr. Powell isn’t likely to prejudge the outcome of this review, but he could offer clues about any ideas he thinks are likely to merit consideration.
The Balance Sheet
Fed officials have indicated they are ready to end the runoff of their $4 trillion asset portfolio later this year. Officials have said they plan to continue shrinking their holdings of mortgage securities even after the runoff ends, leaving primarily Treasurys.
They have yet to decide, however, where along the maturity distribution they should target future purchases of Treasurys. This will be important to credit markets and the economy more broadly because Fed officials have long argued that the duration, as opposed to the volume, of their holdings provided more or less stimulus.
Members of Congress often treat the Fed chief as the CEO of the economy, peppering him or her with lots of questions on issues other than the Fed’s primary duties, which are monetary policy and bank regulation.
Mr. Powell sometimes parries inquiries about tax, trade or immigration policy by noting that he doesn’t want to stray “out of my lane.” This reflects Mr. Powell’s view that the best way to protect the Fed’s independence on monetary policy is to avoid opining too much on other topics.
Preserving the Fed’s independence—and more broadly, enhancing the central bank’s standing as a nonpartisan institution that provides clear analysis—remains one of his top priorities. Mr. Powell’s interactions with members of Congress, including some Republicans who have been apprehensive about Mr. Trump’s criticisms of the Fed, could illustrate his degree of success so far in bolstering the central bank’s political standing.
Mr. Powell could face questions from lawmakers over his dinner earlier this month with Mr. Trump. Look for Mr. Powell to repeat his commitment to nonpartisan analysis.
In what could be an immensely entertaining episode of political theater, Powell will deliver the second part of his biannual Congressional testimony to the House Financial Services Committee on Wednesday, which, for the first time since he joined the Fed in 2012, is controlled by Democrats. We’re certainly looking forward to Powell squaring off with Chairwoman “Kerosene” Maxine Waters and Alexandria “Socialist Sandy” Ocasio-Cortez.
Read Powell’s prepared testimony below:
Good morning. Chairman Crapo, Ranking Member Brown, and other members of the Committee, I am happy to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress.
Let me start by saying that my colleagues and I strongly support the goals Congress has set for monetary policy–maximum employment and price stability. We are committed to providing transparency about the Federal Reserve’s policies and programs. Congress has entrusted us with an important degree of independence so that we can pursue our mandate without concern for short-term political considerations. We appreciate that our independence brings with it the need to provide transparency so that Americans and their representatives in Congress understand our policy actions and can hold us accountable. We are always grateful for opportunities, such as today’s hearing, to demonstrate the Fed’s deep commitment to transparency and accountability.
Today I will review the current economic situation and outlook before turning to monetary policy. I will also describe several recent improvements to our communications practices to enhance our transparency.
Current Economic Situation and Outlook The economy grew at a strong pace, on balance, last year, and employment and inflation remain close to the Federal Reserve’s statutory goals of maximum employment and stable prices‑‑our dual mandate.
Based on the available data, we estimate that gross domestic product (GDP) rose a little less than 3 percent last year following a 2.5 percent increase in 2017. Last year’s growth was led by strong gains in consumer spending and increases in business investment. Growth was supported by increases in employment and wages, optimism among households and businesses, and fiscal policy actions. In the last couple of months, some data have softened but still point to spending gains this quarter. While the partial government shutdown created significant hardship for government workers and many others, the negative effects on the economy are expected to be fairly modest and to largely unwind over the next several months.
The job market remains strong. Monthly job gains averaged 223,000 in 2018, and payrolls increased an additional 304,000 in January. The unemployment rate stood at 4 percent in January, a very low level by historical standards, and job openings remain abundant. Moreover, the ample availability of job opportunities appears to have encouraged some people to join the workforce and some who otherwise might have left to remain in it. As a result, the labor force participation rate for people in their prime working years‑‑the share of people ages 25 to 54 who are either working or looking for work‑‑has continued to increase over the past year. In another welcome development, we are seeing signs of stronger wage growth.
The job market gains in recent years have benefited a wide range of families and individuals. Indeed, recent wage gains have been strongest for lower-skilled workers. That said, disparities persist across various groups of workers and different parts of the country. For example, unemployment rates for African Americans and Hispanics are still well above the jobless rates for whites and Asians. Likewise, the percentage of the population with a job is noticeably lower in rural communities than in urban areas, and that gap has widened over the past decade. The February Monetary Policy Report provides additional information on employment disparities between rural and urban areas.
Overall consumer price inflation, as measured by the 12-month change in the price index for personal consumption expenditures (PCE), is estimated to have been 1.7 percent in December, held down by recent declines in energy prices. Core PCE inflation, which excludes food and energy prices and tends to be a better indicator of future inflation, is estimated at 1.9 percent. At our January meeting, my colleagues and I generally expected economic activity to expand at a solid pace, albeit somewhat slower than in 2018, and the job market to remain strong. Recent declines in energy prices will likely push headline inflation further below the Federal Open Market Committee’s (FOMC) longer-run goal of 2 percent for a time, but aside from those transitory effects, we expect that inflation will run close to 2 percent.
While we view current economic conditions as healthy and the economic outlook as favorable, over the past few months we have seen some crosscurrents and conflicting signals. Financial markets became more volatile toward year-end, and financial conditions are now less supportive of growth than they were earlier last year. Growth has slowed in some major foreign economies, particularly China and Europe. And uncertainty is elevated around several unresolved government policy issues, including Brexit and ongoing trade negotiations. We will carefully monitor these issues as they evolve.
In addition, our nation faces important longer-run challenges. For example, productivity growth, which is what drives rising real wages and living standards over the longer term, has been too low. Likewise, in contrast to 25 years ago, labor force participation among prime-age men and women is now lower in the United States than in most other advanced economies. Other longer-run trends, such as relatively stagnant incomes for many families and a lack of upward economic mobility among people with lower incomes, also remain important challenges. And it is widely agreed that federal government debt is on an unsustainable path. As a nation, addressing these pressing issues could contribute greatly to the longer-run health and vitality of the U.S. economy. Monetary Policy Over the second half of 2018, as the labor market kept strengthening and economic activity continued to expand strongly, the FOMC gradually moved interest rates toward levels that are more normal for a healthy economy. Specifically, at our September and December meetings we decided to raise the target range for the federal funds rate by 1/4 percentage point at each, putting the current range at 2-1/4 to 2-1/2 percent.
At our December meeting, we stressed that the extent and timing of any further rate increases would depend on incoming data and the evolving outlook. We also noted that we would be paying close attention to global economic and financial developments and assessing their implications for the outlook. In January, with inflation pressures muted, the FOMC determined that the cumulative effects of these developments, along with ongoing government policy uncertainty, warranted taking a patient approach with regard to future policy changes. Going forward, our policy decisions will continue to be data dependent and will take into account new information as economic conditions and the outlook evolve.
For guideposts on appropriate policy, the FOMC routinely looks at monetary policy rules that recommend a level for the federal funds rate based on measures of inflation and the cyclical position of the U.S. economy. The February Monetary Policy Report gives an update on monetary policy rules. I continue to find these rules to be helpful benchmarks, but, of course, no simple rule can adequately capture the full range of factors the Committee must assess in conducting policy. We do, however, conduct monetary policy in a systematic manner to promote our long-run goals of maximum employment and stable prices. As part of this approach, we strive to communicate clearly about our monetary policy decisions.
We have also continued to gradually shrink the size of our balance sheet by reducing our holdings of Treasury and agency securities. The Federal Reserve’s total assets declined about $310 billion since the middle of last year and currently stand at close to $4.0 trillion. Relative to their peak level in 2014, banks’ reserve balances with the Federal Reserve have declined by around $1.2 trillion, a drop of more than 40 percent.
In light of the substantial progress we have made in reducing reserves, and after extensive deliberations, the Committee decided at our January meeting to continue over the longer run to implement policy with our current operating procedure. That is, we will continue to use our administered rates to control the policy rate, with an ample supply of reserves so that active management of reserves is not required. Having made this decision, the Committee can now evaluate the appropriate timing and approach for the end of balance sheet runoff. I would note that we are prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. In the longer run, the size of the balance sheet will be determined by the demand for Federal Reserve liabilities such as currency and bank reserves. The February Monetary Policy Report describes these liabilities and reviews the factors that influence their size over the longer run.
I will conclude by mentioning some further progress we have made in improving transparency. Late last year we launched two new publications: The first, Financial Stability Report, shares our assessment of the resilience of the U.S. financial system, and the second, Supervision and Regulation Report, provides information about our activities as a bank supervisor and regulator. Last month we began conducting press conferences after every FOMC meeting instead of every other one. The change will allow me to more fully and more frequently explain the Committee’s thinking. Last November we announced a plan to conduct a comprehensive review of the strategies, tools, and communications practices we use to pursue our congressionally assigned goals for monetary policy. This review will include outreach to a broad range of stakeholders across the country. The February Monetary Policy Report provides further discussion of these initiatives.