Jackson Hole: Looking Beyond the Here and Now

With Jackson Hole in the rearview mirror, Fed watchers already are looking ahead to the Fed’s next play, including the final three meetings this year of the Federal Open Market Committee.

But moving on too quickly misses the opportunity to consider what Jackson Hole truly represents.  The annual event is rarely meant to provide direct consequences of the monetary policy game. Instead, it offers insight into how policy officials are reading the game and the season ahead, readying their toolkits for the rest of the season. For us Fed watchers, it’s not insight into the next play itself; if we tune in, we get the full playbook.

Warsh’s speech: Immediate reaction

First, a quick recap of the immediate reaction to Fed Chair Kevin Warsh’s speech:

For a chair who has pledged the Federal Reserve will be less verbose than in the past, speaking only when it has something to say, it’s notable that the speech lasted for over 30 minutes and spanned about 3,500 words. Thus, we must conclude that indeed Warsh believed he had something he wanted to tell markets. I distill what markets heard into only 50 words.  

1. Financial conditions are not restrictive.

2. Labor markets are consistent with “full employment.”

3. Inflation is above target and underlying trends have not meaningfully improved.

4. If inflation is not moving toward the Fed’s 2% objective, clearly and with sufficient speed, the Fed must act.

The market interpreted this as a likely hike coming at the Fed’s next meeting.  While it is possible we may get exactly that, those interpreting Friday’s speech as justification would likely end up “right” but for the wrong reasons.  

For a Fed chair that has suggested the era of forward guidance is a relic of the past, I struggle to describe Warsh’s remarks as anything other than forward guidance.  While this stops well short of a distinct commitment to future policy, that form of explicit guidance has been absent for many years.  So, if not forward guidance, how must we read this speech?

Warsh’s speech: The big picture

I believe it would be wrong to only judge this speech through the lens of a Fed chair seeking to steer markets. I believe Warsh truly wishes to exit the regime of forward guidance, and parsing his speech with that in mind can shed new light on his conclusions.

In his speech, the Fed Chair cited as a first principle the need to “interrogate reality” to learn the difference between yesterday’s news – high inflation – and what is happening now.  Second, the Fed must look at supply-side conditions to better infer the intersection of supply and demand, and thus inflation itself. Inflation is too much demand chasing too few goods, but perhaps we can fix the “too-few-goods” side instead.  

Throughout his speech, Warsh suggested a belief that artificial intelligence has the potential to increase productivity, which could ease supply-side challenges the economy currently faces, while also stressing an equal weighting of the employment side of the Fed’s dual mandate.  I believe the Fed chair was attempting to paint a far more nuanced picture, indicating that while yesterday’s data may be clear, the outlook is more complicated.

In effect, I think the Fed chair was shifting the narrative entirely. That’s appropriate, since the environment in which the Fed operates today is different in six critical aspects than previous Fed chairs faced, although this new regime began under prior Chair Jerome Powell’s tenure.

1. We are no longer in a period of disinflationary forces; instead, inflation is currently above target and has been for many months. (Warsh himself said 65 months, but who is counting?)

2. The Fed must think and act differently in this new regime. I believe Powell failed to make this transition.

3. Old policy tools are dead – out with forward guidance, Operation Twist, quantitative easing, etc. The Fed has one blunt tool: short-term rates.

4. The Fed’s third mandate is one of inflation stability – so long as inflation expectations remain stable, the Fed has time. But with inflation above trend for 65 months, this is a precarious balance. (For more discussion of the third mandate, read my commentary, The Fed and the Myth of 2% Inflation.)  

5. The Fed is willing to cure high inflation.  One cure for high inflation is to lower demand.  Warsh is signaling the Fed is not afraid of curtailing demand, aka slowdown even if it risks a recession. This Fed is willing to take the bitter pill the medicine delivers given the cure is a necessary evil.

6. However, the Fed hopes that instead of lower demand, we will see supply constraints ease in the near term, and there is some hope the data is providing the reprieve.

For those who simply want to know whether the Fed is going to hike, I believe Warsh’s speech suggests that he continues to believe rates can stay on hold. But if inflation doesn’t fall; the Fed will engage in hikes, seeking to tame demand. Without the saving grace of lower oil or AI productivity gains, the Fed stands ready to act.  

I believe time is not on the Fed’s side, and we’ll likely see rate hikes later this year. Yet, I continue to believe that a September hike is unlikely unless the data on inflation turns notably worse.

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