Transitory Complete: Fed Chair Jay Powell Gets Comfortable With the Inflation Hawks

Transitory Complete

Pandemic-era inflation pressures were not transitory after all. The inflation watchers I follow never believed the narrative given the Fed’s insistence on maintaining historically accommodative policy well past its expiration date. Indeed, the transitory in the economy turned out to be the deflationary psychology of Federal Reserve Chair Jerome Powell.

The journey has been quite a ride for Fed-speak. In July 2020, Powell reassured an economy in lockdown shock that the Fed is “not thinking about thinking about raising rates.” When murmurs and then gripes about creeping inflation emerged in early 2021, Powell insisted inflation pressures would be transitory. In late April of that year, Powell explained the theory at that time behind transitory inflation. Transitory stretched out longer and longer and longer, until finally in December, 2021 testimony Powell essentially asked everyone to leave him alone about the unfortunate and untimely phrase. Now, with inflationary pressures worsening, Powell has found inflationista fervor. Powell even declared that the Fed is ready to take rates higher than the neutral rate. The mad scramble has begun; the Fed wants to get a raging fire under control.

A Pivotal Speech

Today, March 21, 2022, Powell gave what I think is the pivotal speech of his career as Fed chair. With the appropriately ominous title “Restoring Price Stability“, Powell started with this proclamation to the 38th Annual Economic Policy Conference National Association for Business Economics assembled in Washington, D.C. (emphasis mine):

“…the current picture is plain to see: The labor market is very strong, and inflation is much too high. My colleagues and I are acutely aware that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials like food, housing, and transportation. There is an obvious need to move expeditiously to return the stance of monetary policy to a more neutral level, and then to move to more restrictive levels if that is what is required to restore price stability. We are committed to restoring price stability while preserving a strong labor market.”

For the folks who might still be in transitory thinking, Powell went on to clarify “…the inflation outlook had deteriorated significantly this year even before Russia’s invasion of Ukraine.”

In racing against the wildfire, Powell and the Fed have an ambitious goal. They want to avoid a recession by tapping the brakes on excessive demand in the economy just enough to gently match limited supply. The strong labor market is both a blessing and a curse in this effort. Powell did not use the term “wage-price spiral” inflation spiral”, but he essentially described such a potential dynamic for today’s economy. Companies are struggling to hire. Employees are shifting into new jobs to gain higher wages.

“There are far more job openings going unfilled today than before the pandemic, despite today’s unemployment rate being higher. Indeed, there are a record 1.7 posted job openings for each person who is looking for work. Record numbers of people are quitting jobs each month, typically to take another job with higher pay. And nominal wages are rising at the fastest pace in decades, with the gains strongest for those at the lower end of the wage distribution and among production and nonsupervisory workers”

Powell summarized: “Overall, the labor market is strong but showing a clear imbalance of supply and demand.” Thus, the Fed feels compelled to “moderate demand growth.” In the process the Fed hopes that the labor market’s very strength will withstand a period of aggressive monetary tightening.

Powell explained that the big surprise came from the stubborn persistence of “supply-side frictions.” The economy cannot handle the rapacious demand in today’s economy without sending prices ever higher. In turn, spiraling inflation threatens to erode wage gains especially for lower-income workers.

No Time to Wait Anymore

Interestingly, Powell provided automobile prices as a good example of the inflation problem. There was a time when commentators insisted soaring car prices would be transitory. Auto prices are now transitory complete. Powell lamented “production remains below pre-pandemic levels, and an expected sharp decline in prices has been repeatedly postponed.” Prices for new cars soared almost all of last year and suddenly look ready to take off again. Used car prices soared even more and could lift again if new car prices rev up again. Regardless, no “base effects” here as worker’s wage gains look sure to come under more pressure.

Source: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: New Vehicles in U.S. City Average [CUSR0000SETA01], retrieved from FRED, Federal Reserve Bank of St. Louis, March 21, 2022.

Source: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Used Cars and Trucks in U.S. City Average [CUSR0000SETA02], retrieved from FRED, Federal Reserve Bank of St. Louis, March 21, 2022.

These mounting pressures have forced the Fed’s hand. The Fed senses it has no time to wait anymore. The Fed is no longer content to wait for the conventional expectations of normalization to bear fruit. In an inflation emergency the Fed needs to act now… (emphasis mine).

“It continues to seem likely that hoped-for supply-side healing will come over time as the world ultimately settles into some new normal, but the timing and scope of that relief are highly uncertain. In the meantime, as we set policy, we will be looking to actual progress on these issues and not assuming significant near-term supply-side relief.”

Inflation is so strong now that Powell has to look out 3 years to envision inflation returning to the Fed’s target of 2%: “I believe that these policy actions and those to come will help bring inflation down near 2 percent over the next 3 years.”

Recession? What Recession?

No Federal Reserve has ever predicted a recession. The central agent trying to command the economy has a vested interest in projecting utmost confidence in its navigation abilities. Accordingly, Powell looked to history as proof that the Fed can pull off the spectacle of the soft landing for the economy:

“I believe that the historical record provides some grounds for optimism: Soft, or at least soft-ish, landings have been relatively common in U.S. monetary history. In three episodes—in 1965, 1984, and 1994—the Fed raised the federal funds rate significantly in response to perceived overheating without precipitating a recession…In other cases, recessions chronologically followed the conclusion of a tightening cycle, but the recessions were not apparently due to excessive tightening of monetary policy. For example, the tightening from 2015 to 2019 was followed by the pandemic-induced recession.”

The Fed is also encouraged by an economy “well positioned to handle tighter monetary policy.”

Powell formerly insisted the Fed would hold rates lower for longer in order to achieve an exceptionally low unemployment rate. The current path flips to the opposite direction. The Fed is willing to go right past the point of neutral rates to get the fire under control: “if we determine that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well.”

Transitory complete. Bring on the inflation hawks.

Be careful out there!