Fed Says Inflation Battle Not Over. Get Ready For More Rate Hikes

 

As reported in this article, Federal Reserve Chair Jay Powell took the podium at the Fed’s annual retreat in Jackson Hole, Wyoming on August 25. What did Powell say, and what are the implications for investors and global markets?

Subject to the usual qualifiers about data dependence and observing economic developments, Powell’s remarks at Jackson Hole were unqualifiedly hawkish. Our expectation is that the Fed will raise interest rates another 0.25% at its next Federal Open Market Committee (FOMC) meeting on September 20. This would lift the fed funds target rate from 5.50% to 5.75%, the highest since 2001.

What specifically did Powell say that counts as hawkish and leans in the direction of at least one more rate hike? Powell started by making reference to his 2022 Jackson Hole speech, which was short, blunt and very hawkish. He said, “My remarks this year will be a bit longer, but the message is the same.”

In other words, he’s still hawkish. He then went on to say, “Although inflation has moved down from its peak … it remains too high. We are prepared to raise rates further if appropriate.” It’s difficult to be clearer than that.

At the June FOMC meeting, the Fed official forecasts projected two rate hikes before the end of 2023. One of those rate hikes occurred at the July FOMC meeting. There are only three meetings left this year – September, November, and December.

If the Fed sticks to its “two rate hike” projection, they will likely raise rates in September and then coast for the rest of the year and into 2024. A rate hike in September is likely to be the last in this series because monetary policy acts with a lag. The lagged effect of prior hikes is still working its way through the system.

By the way, don’t let anyone tell you the Fed is not political. They are hyper-political; it’s just that they do a good job of hiding it.

They know 2024 is an election year. They don’t want to be blamed for a recession if they go too far, and don’t want to be blamed for inflation if they haven’t gone far enough. Their strategy is to finish the job of rate hikes in September, rely on lagged effects to finish off inflation, and distance themselves from a potential recession if one emerges in mid-to-late 2024. The Fed’s hands will be clean.

Powell wasn’t done with his rate hike warnings. After distinguishing between headline inflation and core inflation (excluding food and energy), Powell said, “Twelve-month core inflation is still elevated, and there is substantial further ground to cover to get back to price stability.”

Then Powell said, “Getting inflation sustainably back down to 2 percent is expected to require a period of below-trend economic growth as well as some softening in labor market conditions.”

The bad news for Powell is that the Atlanta Fed projects third-quarter GDP at an annualized rate of 5.9%, which is more than double trend growth. Unemployment is 3.5%, which is the lowest since the 1960s. By either measure, growth or unemployment, Powell is not even close to his goals.

So, Powell’s policy path is clear. He’ll raise rates one more time, likely in September, continue balance sheet reductions, and switch to cruise control until after the election.

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