KEY DATA: Consumption: +0.3%; Disposable Income: +1.1%; PCE Inflation: +0.4%; Ex-Food and Energy: +0.3%/ Sentiment: -10.9 points
IN A NUTSHELL: “The Fed should start slowly tapering its stimulus sometime this year, but rate hikes are well into the future.”
WHAT IT MEANS: Before Fed Chair Powell’s greatly anticipated Jackson Hole speech is dissected, it is worthwhile understanding the condition of the economy from which he is operating. The state of the economy is strong, though the expected moderation is at hand. Consumption rose moderately in July, led by a robust gain in services demand. Goods spending, though, was down. The microchip shortage continues to restrain vehicle sales and durable goods consumption tanked. While the headline number was decent, the rise in spending was more than offset by another sharp increase in inflation. Adjusting for the price increases, real spending declined. That could change, though. Led by the massive July job gain, which powered a jump in wages and salaries, after-tax (disposable) income skyrocketed. Given the more moderate increase in consumption, the savings rate ticked up. So far this year, it has averaged 14.7%. Households have built up a nest egg to spend when the stimulus money runs out.
Normally, when incomes rise, confidence follows. That is not the case right now. The University of Michigan’s Consumer Sentiment Index plummeted in August. The final number was similar to the mid-month result, so there may some stability setting in – though at a level that is below the bottom hit on April 2020. That says a lot.
Powell Speaks: Strong job gains and continued government stimulus funding, including the Biden child tax credit, is supporting the economy. Covid-19, though, continues to suppress confidence and especially expectations. The battle between the two was a key point made today in Fed Chair Powell’s speech to the Kansas City Fed’s Jackson Hole Conference (held virtually). The short story here is that some new ground was plowed, but what the Fed Chair said was pretty much expected. The markets were looking for hints on when the Fed would start reducing (tapering) its purchases of assets. This is the monetary policy equivalent of the open-checkbook policy being run by the federal government. Not surprisingly, he didn’t say the taper was about to begin, but by commenting that “the substantial further progress” test has been met for inflation, as well as “There has also been clear progress toward maximum employment”, the stage has been set for the Fed to announce that they will start to cut back purchases of assets. Barring a setback in the jobs situation, that could come most likely in the November or December FOMC meeting statement.
To ward off another “taper tantrum” in the markets, as occurred in 2013, Mr. Powell spent most of his time explaining why he believes that inflation is coming back down to more normal levels. He has been making the argument that the factors driving the surge in inflation were transitory for a while now, but his defense today was as strong as it gets. I almost believe him. Almost. I am still concerned about what the longer-term trend in inflation winds up as and think it could wind up higher than the current Fed target of an average of 2% over time. It might take another two years before we have a good idea if 2% holds, so it gives economists a lot of time to argue over the issue. The fact that he made it clear that it would be a long time before the Fed’s balance sheet declines, adds to the belief that the Fed will allow inflation to run hot for the foreseeable future.
So, what does this all mean? The Fed is likely to announce that it is slowing, not ending, its purchases of Treasuries and Mortgage Backed Securities (MBS) sometime by the end of this year. It will likely take all next year to taper the level of purchases and only then would it consider reducing its balance sheet and start raising interest rates. The timing is unknown, but that seems like a logical one, as of now. One final comment. Jerome Powell has been a steady hand during the pandemic crisis. He has taken a stand on Fed stimulus and has backed it up with strong economic arguments. Yes, he seems to believe that supporting high and rising markets is one of the three Fed mandates, in addition to legislatively mandated maximum employment and price stability. That has caused the markets to depend upon and therefore demand continued Fed easy money. That is a major concern going forward. He was appointed by Trump, but I don’t think that will stop Biden from reappointing him. His record is solid and not surprisingly, stories have it that Treasury Secretary Clinton supports him. His term ends at the end of January, and he deserves to be reappointed. I suspect that announcement will be made later this year.