Dovish As He Could
Long story short: Powell was certainly not hawkish. Give him another 2-3 good CPI reports and the FOMC will capitulate. In this moment, we forecast core CPI at 0.2% in the next two months. Conditional on that, at the September meeting the FOMC will have 3 consecutive 0.2% readings in core CPI space (with a possible 4th one in September). For this reason, in our view the chance of a hike in September is close to zero. Only thing that matters right now is core inflation. And if it comes below the June SEP, the FOMC has no reason to keep hiking. End of the story.
As usual, we review the most important Q&As below.
(Note: apparently, the Fed staff is no longer forecasting a recession but “only” a significant slowdown in H2. The Fed staff folded-in a recession in the Tealbook post-SVB. What happened this round is that the staff is recognizing that the effects of SVB on the economy are smaller than previously anticipated (say from -0.5% QoQ GDP in Q3 and Q4 to 0%-ish. In this case, the impact on the unemployment rate via Okun law is small (say 1-2 tenths) and the impact on core inflation is even smaller). Not only, but in our estimates this round the softer-than-expected data on core CPI/PCE should mask the upper pressure from the upward revision of the unemployment rate. Put it simply: the news is more cosmetic than substantial)
Q&As
Question. Is another hike likely on the way?
Powell. “[…] we are just going to need to see more data. So, what are we going to be looking at really… it will be the broader, the whole broader picture and starting with… we are looking for moderate growth, we are looking for supply and demand through the economy coming into better balance including in particular in the labor market, we will be looking at inflation, we will be asking ourselves [about] this whole collection of data […] I would say it is certainly possible that we would raise funds again at the September meeting if the data warranted and I would also say it’s possible that we would choose to hold steady at that meeting.”
Comment: we disagree, and this time we keep it simple. Inflation dominates the dual mandate right now. Imagine getting three consecutives 0.2% in core CPI space with a chance of getting a 0.1% in core PCE space before the September meeting. Sure, there is a world in which the “whole collection of data” matters more than a significant progress of disinflation. But it is a world in which we get very large surprises on several fronts (including NFPs). Otherwise, the baseline to us remains no hike in September.
For the record, this is in line with what Powell said replying to the first question of Nick Timiraos. Powell said “we’ll be looking at the labor market data very closely of course, and making an overall judgment of […] the data I think but with a particular focus on making progress on inflation”.
Question. What if growth remains strong?
Powell. “So I would say it this way. The overall resilience of the economy, the fact that we’ve been able to achieve disinflation so far without any meaningful negative impact on the labor market, the strength of the economy overall… that’s a good thing. It’s good to see that of course, it’s also good to see consumer confidence coming up, and things like that will support activity going forward. But you’re right though: at the margin stronger growth could lead overtime to higher inflation, and that would require an appropriate response for monetary policy. So, we’ll be watching that carefully and seeing how it evolves over time.”
Comment: The crucial word is “could” (“could lead overtime to higher inflation”). The truth is that: (i) it is not optimal for the Fed to crush the labor market, (ii) so far we have disinflated via V/U. If growth remains at (or below) potential, there is a path for core inflation to moderate further. And as Powell said, if growth will be higher, we will re-assess.
Question. Why not pausing again if the data came in as expected?
Powell explained that the reason why the FOMC raised the FF rate is because (with respect to the June SEP) the data came in “broadly consistent, not perfectly consistent but broadly consistent with expectations… […] the inflation report was actually a little better than expected but you know we are going to be careful about taking too much signal from a single reading”.
Comment: true. But what about from 3-4 consecutive soft core CPI readings? See you in September, Mr. Chair.
Question. Inflation has fallen. What part of the story is due to rate hikes?
Powell gave a very convoluted answer in which he talked about the supply/demand misalignment and the transmission of monetary policy to the housing market.
Comment: very surprising to see Powell not mentioning the most obvious (and spectacular) channel: the Dollar. As Corsetti and Trezzi (2023) have shown, the relative behavior of core import prices in the US and the Euroarea is an evidence that monetary policy in the US has protected consumers from imported inflation more than in Europe.