Jerome Powell at Jackson Hole, Wyoming, August 24, 2018.
David A. Grogan | CNBC
Fed Chairman Jerome Powell faces the tough challenge of presenting a unified voice on Fed policy from the most divided Fed in years, and that could create volatility if he doesn’t assure markets the Fed will continue to cut interest rates.
Powell will speak at the Fed’s annual Jackson Hole symposium at 10 a.m. ET Friday to an audience of central bankers and economists. His speech comes as the Fed and Powell are under unprecedented siege from an angry president and are also losing the confidence of fearful markets.
“He’s in a bit of a tough bind. His committee is divided. He’s under a lot of pressure from the president, and most importantly the U.S. data has been relatively resilient and that doesn’t provide him a tremendous amount of justification to meaningfully ease,” said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch.
As of Thursday morning, fed funds futures were pricing in more than 90% odds for a 25 basis point rate cut at the September meeting, and between one and two further quarter-point cuts between then and the end of the year.
“I think Powell is going to try and thread the needle on how the committee is viewing the outlook,” said Cabana. “He could sound more dovish himself, marginally more concerned, but I don’t think he’s going to feel comfortable committing to ease, and that’s what the market wants to hear. I think the risks are the Fed could disappoint.”
Economists say the Fed is divided between those who need to see proof the U.S. economy is eroding and those who want to protect it from the headwinds coming from weakness elsewhere in the world. According to the Fed’s minutes from its July meeting, there are two members who wanted the Fed to cut interest rates more, by 50 basis points; two dissenters who didn’t want a cut at all, and a few other, nonvoting members who also didn’t want the Fed to take action.
“They’re sticking to the view that the economy needs to crack before they want to ease. I think that’s the wrong view,” said Michael Gapen, chief U.S. economist at Barclays. Those opposed to a rate cut “appear to be less willing to accept the argument that if they don’t ease, they’re getting tightening,” he said.
Philadelphia Fed President Patrick Harker told CNBC on Thursday he didn’t see the need for another cut. While Harker is not a voting member, his comment added to negative market sentiment and worries the Fed would not act aggressively enough to prevent the economy from falling into recession.
Adding to the negative sentiment on Thursday was a report that showed the manufacturing sector contracting for the first time in the U.S. since the financial crisis. The Markit PMI manufacturing data fell to 49.9. Below 50 marks declining activity.
“The rest of the world looks shaky. If we do nothing, the dollar will likely appreciate, and we will import tightening,” said Gapen.
Gapen said the Fed meeting minutes confirmed the split at the Fed that was already well known. “There were probably five or six who didn’t want to move, and I would put that as Harker, [Atlanta Fed President Raphael] Bostic, [Richmond Fed President Tom] Barkin, [St. Louis Fed President Esther] George, [Dallas Fed President Rob] Kaplan and [Cleveland Fed President Loretta] Mester,” he said.
Strategists said the more disagreement at the Fed the more uncertain markets are about policy, and now the markets are convinced the Fed could fail to head off a recession. As a result, the widely watched 2-year to 10-year yield curve inverted briefly a couple of times in the past week. Other parts of the curve are already inverted, meaning the short term yield has risen above the longer term yield. That is viewed as a reliable recession signal.
“He just has to make sure everyone else who wants to ease will vote with him,” said Gapen. “The market has a view that the rest of the world looks awfully shaky. They think policy has to ease in the U.S. and globally … For whatever reason they think the Fed is constrained, either by their internal split, or by politics against it.”
Powell has said the Fed would act as appropriate in the face of global weakness, concerns about the trade war and stubbornly low inflation, ahead of the Fed’s quarter-point rate cut in July. But his comments after the July meeting that the Fed was making a “midcycle adjustment” or an insurance cut to head off weakness shook up markets that have been looking for a more aggressive Fed rate-cutting cycle.
“If ‘midcycle adjustment’ is not in the Jackson Hole speech, people will interpret that as opening the door for more cuts, as opposed to just two or three,” said Gapen, who expects three more cuts by the end of the year.
Economists also expect Powell to discuss low inflation and a proposal to allow inflation to move in a wider band on both sides of its 2% inflation target.
John Briggs, head of strategy at Natwest Markets, said Powell should point to the three things the Fed said were behind its July rate cut, when it released the minutes of its meeting.
Powell should mention “the business sector; the risk management perspective given the global outlook and the outlook for inflation, and talk about how they’re still watchful of the risks and they will respond as needed,” Briggs said.
Powell could again create volatility when he speaks. “He comes out and he’s hawkish and dovish,” said Briggs. The market reacted after the Fed’s last meeting because the Fed issued a statement that was dovish, Briggs said, and then he gave a hawkish press conference.
Powell is expected to try to sound balanced in keeping options open, while stressing that he is ready to cut rates if the U.S. economy weakens and also as a preventative measure.
“The risk is Jay Powell ends up disappointing markets by not committing enough to a rate cut in September, because he can’t commit,” said Diane Swonk, chief economist at Grant Thornton. “The domestic economy is showing some improvement. We’ve been seeing strong consumers, still weak manufacturing activity, still weak investment. That’s been the dilemma we’re in. … The division is between the traditionalists who want to stay in their own lane, which is domestically oriented. They don’t want to be a global Fed. They don’t want to be on the global highway.”
Powell may give the appearance of calm when he glides in view of cameras at Jackson Hole. But in truth, Gapen said, the last time the Fed had so much internal dissent was 2011, when former Chairman Ben Bernanke was promoting a long period of low rates and unorthodox easing programs during the financial crisis. At the time, three members dissented.
Fed watchers say it’s hard to tell just how much disharmony there was on previous Fed boards because the Fed was less transparent in the past, and other Fed chairs may have been better at reining in disagreement. Cabana said former Fed Chair Janet Yellen faced two dissenters in December 2017, a meeting where the Fed raised rates.
Gapen said the past political pressure on the Fed was from Congress, particularly when it questioned the Fed’s growing balance sheet. But now the Fed, and Powell personally, face increasing attacks from President Donald Trump, who says the Fed has been too slow to cut rates.
That makes Powell’s job even more difficult, and the Fed Chairman has made it clear he views the Fed as independent and that he will not resign or leave before his term is up.
“It’s hard to paint a picture of a consensus when there is no consensus,” said Swonk. “Consensus is very fragile.”