“The job is not fully done”, But..
Powell delivered a press conference in line with the models, something along the lines “there are encouraging signs but take time because they are still not converging to 2%”. While this message is neutral, Powell also gave a rational for both a higher and lower path of the FF rate (which was taken mostly as a dovish signal). To us, Powell’s intention was to remind that the Fed can recalibrate policy, if needed. Having said so, given where markets are, the implicit message (which was a surprise) is that Powell will push back only if the data will be worse than the Fed expects. If this interpretation is correct, we suspect the hawks will progressively lose voice and that the balance is turning at the FOMC table.
Remarks
Powell: “The inflation data received over the past three months show a welcome reduction in the monthly pace of increases. And while recent developments are encouraging, we will need substantially more evidence to be confident than inflation is on a sustained downward path”.
Comment: Powell’s words should be unsurprising to our readers. Some reporters asked Powell “What does substantial more evidence mean?”. The answer is simple, although Powell cannot really say it in public: the medium-term models/forecast need to send the right signals. As you know, we are not there yet.
Q&As
Q1. We have seen a deceleration in prices and wages without an increase in the unemployment rate (U). Does this change your view on how U needs to go up to control inflation?
Powell: “It is a good thing that the disinflation that we have seen so far has not come at the expense of weaker labor market. But I would also say that disinflationary process that you now see underway is really at an early stage. What you see is really good in the goods sector. You see inflation now coming down because of supply chains have been fixed. […] The issue is that we have a large sector called core not housing services where we don’t see this (dis)inflation yet.”
Comment: Very convoluted answer to say the following: we have always known that a portion of the current inflation was driven by factors outside the Phillips curve (i.e. supply chains). Having said so, the disinflation we see today in goods is also (and possibly largely) driven by monetary policy through the dollar. Finally, the sectors more sensitive to cyclical conditions are still to disinflate. Therefore, the baseline for the Fed remains the same.
Q2. Where does the FF rate need to go?
Powell: “Obviously back in December the median was between 5 and 5¼. At the March meeting we are going to update those assessments. We did not update them today. We did however continue to say that we believe ongoing rate hikes will be appropriate to attain sufficiently restrictive stance of policy to bring inflation back down to 2% […] we still think there’s work to do there. […] I continue to think that it’s very difficult to manage the risk of doing too little and finding out in six or 12 months that we actually were close but didn’t get the job done. […] We have a sector that represents 56% of the core inflation index where we don’t see disinflation yet. […] There are many factors driving inflation in that sector. […] so far, we don’t see that [disinflation]. And I think until we do see it, we see ourselves as having a lot of work left to do.”
Comment: Powell and the FOMC still have in mind brining the FF rate to 5%-ish because, as mentioned, this is still what the models suggest, given the estimated persistency of the process. The risk of remaining above target continues to be high. Until it moderates, we expect the FOMC to deliver the same message.
Q3 Why more work to do? Do you really need to increase rates so much?
Powell: “I guess I would say it this way. We can now say, I think for the first time, that the disinflationary process has started. And we see it really in goods prices. […] This is a good thing but that’s you know around ¼ of the PCE price index.” After this Powell talked about housing services and services ex housing where the Fed does not see signs of disinflation yet. Again Powell: “So it’s not that we’re not either optimistic or pessimistic. We’re just telling you that we don’t see inflation moving down yet […] we are just going to have to complete the job, I mean that’s what we’re here for.” Replying to another question, Powell said: “Most forecasters would think that the significantly negative readings [in core goods, ndr] will be transitory and that goods inflation will move up fairly soon back up to its longer run trend of something around zero. So, a lot of forecasts would call for core PCE to go back up to 4% by the middle of the year”.
Comment: Worth reminding that the disinflation achieved so far is in the goods sector because the dollar has appreciated following restrictive monetary policy. Therefore, unless there will be convincing signs of disinflation in the services sector, interests rates will remain elevated.