Federal Reserve uncertain of direction of economy as Wall Street meltdown deepens
“It’s very difficult to say with precise certainty how it’s going to play out,” Powell told reporters this week. “…Nobody knows whether this process will lead to a recession or, if so, how big that recession would be.”
Public admissions of doubt are rare in official Washington. But they have become commonplace for Powell, 69, whose candor reflects uncertainties surrounding the global economy as well as a revolution in Fed communications from when then-Chairman Alan Greenspan cultivated an image of singular economic mastery.
But Powell’s final remarks come as The Fed’s fight against inflation is progressing only slowly, leaving the institution and its boss vulnerable to criticism over the cost to workers and businesses of continued rate hikes.
The Dow Jones Industrial Average fell for the fourth day in a row on Friday, falling below 30,000 for the first time since June and wiping out everything investors had gained since November 2020.
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“People see the Fed as the best source for where we’re going. The Fed has information. They have highly qualified staff. They have no political reason to hide the ball,” said Claudia Sahm, who spent 12 years as a Fed economist. “Everyone wants to know where we will be next year… But in reality, the Fed is just as blind as the rest of us.”
After incorrectly predicting for most of last year that inflation would prove ‘transient’, Powell pointed to the complexities involved in turning around the $25 trillion US economy as it shakes by an unusual mix of forces.
Indeed, no one has seen an economy like today’s. Tangled supply chains. The spike in world food and fuel prices, triggered by Russia’s invasion of Ukraine. Factory closures in China resulting from an unpredictable pandemic.
The cumulative impact has repeatedly surprised Fed forecasters, Wall Street analysts, White House officials and corporate executives. Current inflation readings are “not where we expected or wanted to be,” Powell conceded this week.
Even with the additional rate hikes planned, the Fed does not expect annual inflation to return to its price stability target of 2% before the end of 2025.
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“You have to make your best guess with limited data and limited understanding,” said Marc Chandler, Managing Director of Bannockburn Global Forex. “The Fed not only recognizes that they got it so wrong, but that there is no playbook. How do you play these multiple shocks?
The deep uncertainty is not slowing the Fed down.
Powell’s comments to reporters on Wednesday came as he unveiled the central bank’s fifth interest rate hike this year, all designed to slow the economy and ease pressure on prices. Since March, the Fed has raised its key rate by 3 percentage points, the fastest increase of that size since 1982.
The Fed chief said rates would likely rise another 1.5 points before the end of the year. Some economists believe the central bank should pause to assess the impact of its past efforts to slow the economy before proceeding with further increases. But Powell’s bet is that the costs involved in losing control of inflation outweigh the dangers of pushing the economy into a recession.
To dispel some of the analytical fog, the Fed also released quarterly economic forecasts from its top officials this week.
Wall Street analysts look to the numbers, which are the most reliable guide to the assumptions guiding monetary policy.
Still, Powell suggested there is spurious precision in the projections, which are specified down to a tenth of a percentage point through 2025.
“No one knows for sure where the economy will be in a year or more,” he said.
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It’s a polite way of saying that the Fed’s best guesses are often wrong. At the beginning of this year, for example, the median projection of the Fed’s favorite inflation gauge called for prices to rise this year by 2.6%.
The latest estimate now calls for inflation of 5.4% this year, more than double the initial forecast.
“What Powell is doing is communicating that the way the economy is going is ambiguous and how they might have to react is equally uncertain,” said Nathan Sheets, chief global economist for Citigroup. “We have entered a period where many Fed models and equations have gone off the rails. They have less visibility for this reason on the evolution of the economy.
The Fed only began publishing these internal forecasts in 2007 as part of an effort by then-Fed Chairman Ben Bernanke to promote greater transparency in central bank deliberations. In 2011, Bernanke also began holding a quarterly press conference to discuss Fed thinking.
Under Greenspan, who chaired the Fed from 1987 to 2006, the central bank was mostly silent. There were no regular press conferences, no public broadcast of officials’ projections, and Greenspan boasted a deliberately inscrutable style of public speaking.
“If I turn out to be particularly clear, you probably misunderstood what I said,” he told an audience.
Greenspan was lucky enough to command the Fed after the high inflation of the 1970s died out. His tenure also coincided with a technology-related productivity boom and the first financial gains associated with China’s entry into the the global trading system, which have helped keep inflation low for years.
As the American economy boomed and the stock market soared, Greenspan’s reputation also rose.
“Greenspan benefited from his presidency of the Fed during a period of many favorable shocks,” Sheets said. “When things are going well in the economy, it’s much easier for a decision-maker to look brilliant.”
Powell did not have that luxury. A seasoned corporate lawyer and investment banker, he was appointed to the post in 2018 by former President Trump – who regularly berated him on Twitter – and reappointed for a second four-year term by President Biden more early this year amid the worst inflation in four decades. .
To combat annual consumer price inflation of 8.3%, the Fed plans to raise interest rates until the economy slows. Making credit more expensive has already caused the housing market to decline and Powell warned that beating inflation would mean “pain”.
As economic weakness spreads, employers will first eliminate vacancies and then start laying off workers, economists have said.
The Fed expects the jobless rate to hit 4.4% next year, from 3.7% today. Many private forecasters are more pessimistic. Bank of America economists said Friday that the unemployment rate will peak at 5.6% in December 2023, implying a flood of pink slips that could cost more than 3 million Americans their jobs.
Central bank actions are already hurting investors. Since the Fed began raising interest rates in March, global stock markets have lost $12 trillion in value, according to data compiled by Bloomberg.
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Powell’s extensive efforts to explain to Americans what’s going on with the economy have raised some doubts. After the Fed Chairman’s last press conference, Lawrence Summers, the former Treasury Secretary, asked on Twitter “if the Fed’s credibility is well served by frequent hour-long dialogues on the hypothetical and the ‘unpredictable”.
Chairman Powell is very thoughtful at press conferences, but I wonder if the Fed’s credibility is well served by frequent hour-long dialogues about guesswork and the unpredictable, against the backdrop of revolving markets.
—Lawrence H. Summers (@LHSummers) September 21, 2022
The Fed “should consider the idea of TMI,” a shorthand for too much information, Summers added.
Despite the snark, financial markets still believe the Fed will deliver on its promise to rein in rising prices. Investors expect inflation to average 2.4% over the next 10 years, according to the market indicator derived from US Treasury yields. That’s down from 3% in April and close to the Fed’s target.
It should be remembered that Greenspan’s reputation for omniscience did not last. During the 2008 financial crisis, as trillions of dollars in wealth evaporated and the ranks of the unemployed swelled, critics in Congress cited the near collapse of the US banking system as evidence that its confidence in the ability industry to control itself had been misplaced.
Testifying in October 2008 before the House Government Oversight Committee, Greenspan confessed that the crisis had exposed “a flaw” in his thinking.
“I still don’t fully understand why it happened,” he said.
His successor is determined to do better. Powell was committed to beating inflation no matter the cost and time required. Not having all the answers is no excuse for inaction.
“Inflation is too high,” Powell said in conclusion. “You don’t really need to know much more than that.”