Federal Reserve officials have been attempting to convince markets of their commitment to fighting inflation by explicitly talking about the unwelcome costs they are willing to bear and inflict to succeed.
Fed Chair Jerome Powell first engaged in this tough guy talk last summer in Jackson Hole. In that short yet memorable speech, Powell spelled out the costs of tightening quite explicitly. Growth would fall below its long-term average, labor markets would take a hit, and both businesses and households would be squeezed by higher interest rates, Powell explained.
“Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” Powell said.
The point of this was to dispel the idea that the Fed would flinch in the face of an economic downturn. Prior to Jackson Hole, many on Wall Street and beyond were convinced that a recession would force the Fed to cease its rate hikes early and begin cutting interest rates in 2023. The talk that the Fed could achieve its goal of taming inflation with a “soft-landing” for the economy had convinced many that if a hard-landing looked more likely, the Fed would back off of the inflation fight.
This worked for a time. Yet as the new year has dawned, financial conditions have continued to ease as the stock market presses ahead and borrowing costs have eased significantly from the October highs. In just the first week of this year, companies have issued $63.7 billion in U.S.-marketed debt, up from a total of $36.6 billion in the last five weeks of 2022, according to a report in the Financial Times citing data from Dealogic. This is not what is supposed to happen when financial conditions are allegedly “restrictive.”
The Fed itself is aware of this. The minutes from the December meeting contain a not-very-subtle complaint about easier financial conditions.
“Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability,” the minutes say.
It’s clear that Powell’s vague talk about “some pain” and “below-trend growth”—as startling as it was last August—is not carrying much weight with markets. So Fed officials have taken to being more explicit about the economic, social, and political headwinds they expect to face and overcome in their crusade against inflation.
We pointed out on Monday that the Fed minutes from the December meeting included very explicit discussion of the likelihood that a higher unemployment rate will disproportionately inflict joblessness on black and Hispanic Americans. In an era obsessed with racial equity and justice, this is an extremely hawkish statement. Fed officials have acknowledged that their inflation fight is likely to be what the left now calls systemically racist.
In a speech in Stockholm on Tuesday, Powell said that Fed officials expect political blowback.
“Price stability is the bedrock of a healthy economy and provides the public with immeasurable benefits over time,” Powell said. “But restoring price stability when inflation is high can require measures that are not popular in the short term as we raise interest rates to slow the economy.”
Powell is trying to warn Wall Street that it is not going to win this fight. Wall Street, however, is not yet in the mood to receive the message.
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