Federal Reserve (Fed) Chair Powell delivered exactly the right message for financial markets during Friday’s Jackson Hole speech. The S&P 500 Index reached another all-time high — marking its 52nd record close this year — and interest rates fell across the yield curve. Long Treasury Inflation-Protected Securities (TIPS) rose nearly 2.5 points with yields moving deeper into negative territory, close to historically low levels. Investors took comfort in Powell’s promise that despite the tapering of bond purchases likely to begin this year, liftoff from the zero-interest-rate level would be subject to a “different and substantially more stringent test.”
Powell’s dovish tone ran counter to messaging earlier in the week from numerous Fed officials, who appeared to be preparing markets for a faster timeline to policy normalization. The wide-ranging communication coming from Fed officials last week may be a sign of growing disagreement inside the Fed, as the pandemic continues to complicate the outlook for labor markets and inflation.
On the employment front, Powell still believes the Fed has “considerable remaining ground” to cover to reach maximum employment, especially with labor force participation well below pre-pandemic levels. While he continues to see slack in the labor markets, other factors would suggest full employment may already be at hand, with record-high job openings and quit rates, and employers struggling to find workers.
Chair Powell’s views on inflation also appear out of touch with views from other Fed officials who are not convinced the recent spike in inflation will be transitory. His statement on Friday relating to the Fed’s new average 2% inflation targeting framework was especially puzzling. The Fed chair remains committed to the idea that inflation still needs to be “on track to moderately exceed 2% for some time” despite trailing one-year Personal Consumption Expenditures Price Index inflation coming in at more than twice the Fed’s target. Average inflation targeting means there may be times when inflation needs to run below 2% to meet the target.
The abundant liquidity conditions created by the Fed’s easy money policies are likely to support asset prices over the near term, but the risk remains that higher inflation will force the Fed to react.
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