Don't Miss This. Chairman Powell used the Jackson Hole Policy Symposium this week to introduce the FOMC's Statement on Longer-Run Goals and Monetary Policy Strategy. Rick Rieder, BlackRock global fixed income CIO noted, "In many respects, the Strategy statement represents a mirror image to the Fed's stance more than a generation ago, in August 1979, when Chair Paul Volker took over leadership of the central bank in a manner that highlighted its determination to stamp out extraordinarily high levels of inflation with historically high policy rate levels." So the key takeaway is that the Fed is now prepared to let inflation run modestly above 2% for some time in order to focus on employment gains to combat the massive job losses caused by the Covid pandemic.
Will Markets Believe Them? The Fed will no longer chase the "natural rate", referred to as r* (the rate that would prevail when the economy is at full employment and stable inflation). Models and rules-based policy guidance have now been formally replaced with a more flexible and discretionary approach to monetary policy. This "reframing" of the dual mandate-- with employment being the primary emphasis and price stability (inflation control) only a limiting condition for how far they can push employment--is not new to the markets. However, the question remains, can the Fed actually create inflation on their own? Investors' expectations based on Consumer Price Index caps/floors (call and put options based on CPI) can in part answer this question; whether the markets believe inflation will "run hot," above 2% as the Fed says they will now tolerate. Current analysis of these inflation derivatives by Arbor Data Science indicate markets presently see less than a 50% probability of inflation exceeding 2% across short and long-term maturities. However, these probabilities are rising. A sustained increase in the implied probabilities over 50% would signal the Fed's message is being received as credible by markets.
Historical Perspective. How meaningful would trend inflation in excess of 2% be? Headline and core CPI averaged 1.6% and 1.8% over the past decade. While the macro economic environment today is similar to the past decade-- both starting from high levels of unemployment and expansive monetary policy, 2020 has the added potential for meaningful levels of additional fiscal stimulus. As noted MMT economist and author Stephanie Kelton said on Twitter this week, "so now we sit back and wait to see if Congress delivers."
No Fiscal Cliff Yet. US consumers continue to show resilience in the face of CARES Act programs expiring, even with no clear likelihood of additional support on the horizon. JPMorgan noted this week, "Thus far...we see little sign that the [enhanced unemployment] benefit expiration has marked a major turning point for the overall economy, as many other high-frequency spending and activity indicators have continued to rise in August." Leading categories for consumer spending included housing, autos, education and home office needs.
