Wednesday, December 12, 2018


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Last week, Federal Reserve Chairman Jerome Powell successfully walked back his October remark that jarred investors, but it’s hardly the last challenge he’ll face to communicating the road ahead.

Powell on Wednesday appeared to turn course from his initial stance that the central bank remains “a long way” from a neutral interest rate that would neither rev up nor hold back the economy. His comment, that the Fed Funds rate is near the range of expectations for the neutral rate from other policymakers, helped drive a powerful stock market surge.

However, the path forward doesn’t get any easier — and Powell’s primary challenge will be to avoid the missteps that helped drive a market correction that only reversed course after his speech. The Fed wants to keep normalizing policy, with will do so in the face of worries about an economic slowdown, and increasing pressure from President Donald Trump to keep rates low.

Jerome Powell, Chairman of the Federal Reserve, speaking at the New York Economic Club on Nov. 28th, 2018. 

Adam Jeffery | CNBC
Jerome Powell, Chairman of the Federal Reserve, speaking at the New York Economic Club on Nov. 28th, 2018. 

“I think he did a masterful job this past week,” said Joe LaVorgna, chief economist for the Americas at Natixis. “All he had to do was increase the range of plausible outcomes. I thought it was masterfully done, and reflects the economic realities.”

Whether Powell really changed that much was a matter up for hotly contested debate.

After all, the difference between “a long way” from neutral and near the bottom end of a wide range of estimates for that level didn’t seem to be that much — maybe one or two quarter-point rate hikes, at most. The median estimate of neutral, currently around 3 percent, would still equate to at least three more rate hikes.

'He walked back what he said'

But the perception that Powell does not hold reflexively hawkish views, and is willing to adapt as the data roll in, seemed enough to convince investors that — at least for now — they don’t have to fear the Fed.

Minutes from the November Federal Open Market Committee meeting further indicated that officials will stress the importance of data.

“In fact, he walked back what he said on Oct. 3,” said Quincy Krosby, chief market strategist at Prudential Financial. “He speaks very clearly, so it is not an issue of the market misunderstanding what he said. He said that.”

Less definitive is what Powell meant when he said interest rates “remain just below the broad range of estimates of the level that would be neutral for the economy.”

The market immediately took “just below” to mean that the current benchmark Fed rate — targeted at 2 percent to 2.25 percent — is near neutral, and the central bank may want to halt or slow the pace of increases. A closer reading, though, indicated that the chairman only meant it was below the lower end of estimates from Fed policymakers, who put neutral in a range of 2.5 to 3 percent.

Distinguishing the remarks could be key for the market as the calendar turns to 2019.

Goldman Sachs economists said the market “misleadingly shortened Powell’s formulation” on neutral. Still, the bank conceded that its 2019 forecast might be in some jeopardy.

“Looking beyond the next few weeks, recent events have increased the downside risks to our baseline forecast of quarterly hikes through end-2019,” wrote economists Daan Struyven and Jan Hatzius.

Clarity or confusion

That type of confusion over signaling is the kind of thing Powell will need to avoid as the Fed gets near the end of its tightening cycle. It’s also critical to keep in mind as the Fed continues to unwind its balance sheet, which is loaded with about $4 trillion in bonds it purchased to stimulate the economy.

There are doubters that things can go smoothly.

“In sum, what happens next is watching Powell act out on his belief that he can let the economy manage itself and thereby hold the funds rate steady for an extended period, as [Alan] Greenspan did in the mid-1990s,” Steven Blitz, chief U.S. economist at TS Lombard, said in a note, referring to the former Fed chairman.

“We think [Powell’s] belief will prove misguided — the situation today is so very different,” Blitz added.

There’s another wrinkle ahead for Powell and the markets: News conferences after every meeting from January 2019 forward, meaning that every time the Federal Open Market Committee gets together to talk policy, a rate hike is possible. Previously, Fed chairs have met with the press only after quarterly meetings, and the committee hasn’t hiked rates once, without a chance to explain why afterwards.

The potential is there for either clarity — or confusion.

The market has suddenly taking an optimistic attitude towards the Fed — “symptomatic of despair” and “grasping at straws” was how Gluskin Shuff strategist and economist David Rosenberg put it. That could easily be quelled by one slip of the tongue in public, as Powell already has discovered.

“It’s going to be very important,” Prudential’s Krosby said. “The Treasury market and the other markets are going to be watching.”

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