Orlando's Outlook: Welcome to Jay Powell's Fed

06-15-2018

Bottom Line At the conclusion of its two-day policy-setting meeting on Wednesday, the Federal Reserve (Fed) voted unanimously to raise its benchmark fed funds rate by a quarter point, to a range of 1.75% to 2%. This is the Fed’s second rate hike this year, and the seventh this cycle, since the Fed abandoned its zero interest-rate policy (ZIRP) under previous Fed chair Janet Yellen in December 2015.

Importantly, in a somewhat hawkish turn, eight of the 15 voting Fed officials (up from seven in March and only four last December) adjusted their dot plots more bullishly, which implies that we could see two more rate hikes later this year, rather than only one more, which has been our forecast.

What prompted the Fed’s more aggressive economic outlook? In a word, the U.S. economy is raking. Retail sales in May are surging at a 5.2% annualized rate over the past three months, consumer confidence is running near multi-decade cycle highs, the labor market strengthened last month, manufacturing has gone vertical over the past quarter and the net trade balance improved by 17% over just the past two months to a seven-month low in April.

While we’re carrying an above-consensus estimate for second quarter GDP of 3.5% (vs. 3.2% for the Blue Chip), we note that estimates are now ratcheting higher on this week’s better-than-expected retail sales data, and the Atlanta Fed’s widely followed GDPNow model just raised its estimate to 4.8% from 4.5% last week. That compares with first-quarter GDP of 2.2%.

Policy error brewing? In addition, the Fed now expects that it will raise interest rates three more times in 2019 and once more in 2020, which would take the fed funds rate up to a range of 3.25% to 3.50%. We’ve been expecting a 3% terminal value by the end of 2019, so investors may be concerned that the Fed might over tighten, potentially sowing the seeds for the next recession in 2021. 

Inflation still relatively benign Although it has risen from 1.3% last August and from 1.5% in February, the core PCE is at 1.8% y/y in each of the past two months through April, still below the Fed’s oft-stated 2% target. So the market’s feared inflation spike appears to be more of a gradual grind higher, which could allow the Fed some wiggle room in its future pace of rate hikes. We continue to believe that the Fed would like to elongate the economic cycle. It doesn’t want to raise rates too quickly, lest they choke off growth and push the economy prematurely into recession.

Summer air pocket? The S&P 500 rallied by more than 9% from its April 2 trough to this Wednesday’s June 13 peak, but it has sold off by 1% over the past two days, perhaps due to these new monetary policy concerns, in conjunction with today’s fears of Trump-inspired tariffs and a trade war with China. So we could experience a temporary 5% hiccup during the summer doldrums, which we view as an attractive buying opportunity

Presser every meeting New Chair Jerome “Jay” Powell has begun to put his stamp on the Fed. During Wednesday’s press conference, he used a simple, plain-spoken approach to discuss the state of the economy and the Fed’s monetary policy plans (delivered while standing at a podium), a welcomed change to Yellen’s and Ben Bernanke’s more technical, jargon-filled assessments, delivered while sitting at a desk.

Powell also announced that starting January 2019, he would host a press conference after each of the Fed’s eight policy-setting meetings over the course of the calendar year, rather than the current approach at every other meeting (March, June, September and December). That’s important, because since Chair Bernanke started the post-meeting pressers in 2011 to increase central-bank transparency, the Fed has enacted policy changes only in meetings that also had press conferences so it could explain the policymakers’ thought process to the financial media. That pattern has subconsciously lulled the market into a false sense of security, confident that the Fed was not going to act if there was no presser scheduled. So with a press conference after every meeting, Powell will be able to provide more information and nuance while simultaneously keeping the market on its toes.  

New power troika rounding into view Bill Dudley, president of the important New York Fed and vice chair of the policy-setting Federal Open Market Committee (FOMC) for nearly a decade, will retire this Sunday, June 17, ending a very successful tenure. He will be replaced the following day by John Williams, the highly regarded current president of the San Francisco Fed, who will be swapping coasts. Both Dudley and Williams are Ph.D. economists.

President Trump nominated Richard Clarida for the Fed’s vice chair job, which has been open since Stanley Fischer retired last October. A Ph.D. economist from Harvard, Clarida was a global strategic advisor at bond giant PIMCO, professor of economics and international affairs at Columbia University and assistant U.S. Treasury secretary for economic policy under President George W. Bush. The Senate Banking Committee approved Trump’s nomination this week with a bipartisan 20-5 vote. Although his full Senate confirmation vote has not yet been scheduled, Clarida is expected to successfully advance into the vice chair’s job.

When all of this comes together, the financial markets should be comfortable with the Fed’s new leadership troika of Powell, Williams and Clarida. Importantly, Powell is the first Fed chair since Paul Volker not to be a Ph.D. economist, but that lack of economic gravitas will be complemented by Williams and Clarida. On the other hand, Powell is trained as a lawyer and worked as an investment banker, so his market savvy will be a welcomed skill set at the Fed.

Happy Father’s Day!

Research assistance provided by Federated summer intern Audrey Randazzo

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