In Jackson Hole, Federal Reserve officials unequivocally emphasized their commitment to bringing inflation under control – even as the U.S. economy slows.
By Tiffany Wilding, North American Economist, and Allison Boxer, Economist, at PIMCO
Market participants listened closely to Federal Reserve officials at the annual symposium in Jackson Hole, Wyoming, for any sign of how committed the central bank remains to fighting inflation amid concerns about the associated costs to growth and employment. Chair Jerome Powell’s message in Friday morning’s speech was short, clear, and direct: Inflation remains too high, and the Fed will not back down from doing what it takes to bring inflation under control. Having learned from history, Fed officials warned that they would not be quick to declare victory on inflation. This means investors, businesses, and communities should expect higher interest rates for longer as policymakers commit to sustainably bringing inflation down. With inflation projected to moderate to a still above-target pace, we believe the Fed will deliver additional outsize tightening this year and then keep rates on hold even as the U.S. economy slows into 2023.
Short and to the point
Chair Powell’s much-anticipated speech delivered the hawkish message market participants were looking for. In one of the shortest Jackson Hole speeches by a Fed chair in recent memory, he unequivocally reaffirmed the Fed’s commitment to bringing inflation down even though it is likely to require “some pain.” Chair Powell turned to lessons from history to underscore how today’s Fed officials recognize that they cannot afford to let inflation expectations become unanchored, and that rates will continue to constrain demand until officials are sure that inflation is fully back under control.
Chair Powell’s comments were echoed by other Fed officials in many media interviews occurring alongside the symposium. Despite more muted inflation reports in July across both CPI (Consumer Price Index) and PCE (Personal Consumption Expenditures), Fed officials are not close to being ready to declare victory on inflation. This is consistent with our view that though there are signs of U.S. inflation being at or near a peak on a year-over-year basis, the underlying trend of inflation looks inconsistent with the Fed’s target. Officials were careful to emphasize data dependence and shied away from providing guidance for the next Fed meeting. Instead, they emphasized that market participants should not expect rate cuts – the Fed’s usual reaction to a period of slower growth – to happen anytime soon. The Fed’s communication strategy seems to be allowing flexibility to react to upcoming data in sizing the rate hikes for the remainder of this year, while at the same time tightening financial conditions by pushing back on markets pricing in a quick pace of rate cuts next year.
The symposium in Jackson Hole brought together academics and policymakers to consider the broader lessons from the supply constraints that have been a hallmark of the pandemic period. While Fed officials may be taking each individual data point in turn as they consider the near-term path for policy, these considerations have important implications for monetary policy in the medium and long term. Sessions explored how the pandemic period may affect longer-run productivity, output, and neutral policy rates – raising questions about whether the Fed’s framework needs to evolve to address these new challenges.
More tightening to come
The outlook for higher inflation and lower growth has put the Fed in a tough spot, but the central bankers used Jackson Hole to reaffirm that their key focus remains anchoring inflation expectations by rapidly raising the fed funds rate. This approach has already produced the fastest pace of financial conditions tightening since the 2008 Lehman Brothers bankruptcy, according to PIMCO’s U.S. Financial Conditions Index.1 Over the next few quarters, we expect Fed officials to continue along the path of monetary policy tightening previously laid out, and the messages relayed at Jackson Hole reaffirmed that tighter monetary policy is here to stay despite the challenging outlook for growth.
1 The PIMCO U.S. Financial Conditions Index (FCI) is a proprietary index that summarizes the information about the future state of the economy contained in a wide range of financial variables. The FCI includes such variables as the fed funds rate, bond yields, credit spreads, equity prices, energy prices, and the broad trade-weighted U.S. dollar, all of which will affect the U.S. economy.