Unambiguous Ambiguity

by | August 30, 2021

On Friday, Fed Chairman Powell ‘nailed it’. He managed to talk about the US economic outlook and its risks, as well as convey the Fed’s willingness to ‘taper’ asset purchases before year end—all without upsetting markets. Powell achieved two key goals. He smoothed the way for markets to navigate a critical monetary policy inflection point. And he bolstered his chances to be renominated for a second term as Federal Reserve Chairman.

Powell pulled it off by being unambiguously ambiguous. He was clear in outlining why the preconditions for tapering are likely to be met this year. But he disguised in ambiguity the preconditions for rate hikes, making them appear far off. The bond market held firm, and stocks rallied. 

Powell and the Fed have learned from past communication missteps. To avoid another ‘taper tantrum’ in the bond market, Powell had to sever any perceived links between the decisions to slow asset purchases (‘tapering’) and to raise the Fed Funds rate. The success of his speech rested on his ability to draw a clear distinction between the criteria for tapering and those for rate hikes and to do so in a manner that would push off rate hike expectations to an uncertain future date.  

Powell emphasized that the ‘bar’ for tapering is lower and nearly met. Specifically, he noted that to taper asset purchases the Fed needs to see inflation above its 2% long-term target and the labor market demonstrating ‘substantial progress’. He made it clear that the FOMC believes the inflation objective has now been met. He noted that ‘significant’ gains have been made on labor market measures, a choice of words that suggests the Fed needs to see only a few more encouraging jobs reports before tapering can commence.

By adding that the Fed expects the job market to continue to heal, Powell made tapering probable before year end. The November 2-3 FOMC has become the most likely Fed meeting to announce a slowing of asset purchases.

Powell’s critical accomplishment, however, was to simultaneously signal that interest rate hikes are not linked to tapering.

In part, he achieved that aim by noting that the threshold for rate hikes is much higher. For instance, inflation must sustainably exceed the Fed’s 2% target for an unspecified time. The labor market must do more than accomplish ‘substantial progress’: Full employment must be achieved. 

Those hurdles are at once clear and ambiguous. What is most clear is that those objectives will not be met soon. On inflation, Powell reiterated his view that this year’s jumps in headline, core and wage measures of inflation are largely transitory. Accordingly, a sustainable overshoot of the Fed’s 2% inflation target will require persistent price and wage pressures not yet evident in the data. That could take much longer.

Powell’s clear intent was to emphasize that the inflation criteria for rate hikes will not be met soon. By also noting that inflation must overshoot the Fed’s target for an ambiguous ‘period’, Powell hinted at an even later date for a tightening monetary policy.

Similarly, Powell used the ambiguity of ‘full employment’ to suggest that labor market improvements required for rate hikes could take much longer to realize. For instance, it will take time to better understand the impacts on the labor force participation rate caused by the pandemic, technological change, and demographics. 

Perhaps most important, by linking rate hikes to the restoration of full employment, Powell made monetary policy a function of a traditional lagging indicator. If it were not clear before, it is now: The Fed has renounced the notion of preemptive tightening.

In the terminology of bond markets, Powell bought time in the forward curve—postponing the repricing of shorter duration notes that are typically most sensitive to changing expectations of policy rates. Powell made sure that bond investors were reassured about a stable future path of short-term interest rates, which enables them to solely focus on the yield curve impacts associated with a gradual reduction in Fed purchases of longer-dated maturities. The Fed Chairman deftly used language to smooth the markets’ response to a change policy.

Powell’s speech also made it clear about what data matters most over the next few months. It is all about the labor market. ‘Significant’ progress must become ‘substantial’ progress for tapering to become a certainty. 

Consequently, this week’s ADP, unemployment claims and payrolls data take on even greater importance. On Friday, the August employment report is expected to show a modest slowing of job creation to a still robust 750,000 new jobs, accompanied by a rise in average hourly earnings at a 4.0% annual rate. 

The Fed is primarily interested is seeing whether higher aggregate demand translates into jobs, wages, and household incomes, providing the basis for self-reinforcing gains in spending and jobs—the essence of a sustainable expansion. While the labor force participation rate is also an important variable, Powell has indicated that the FOMC expects labor supply to expand as schools reopen, extended unemployment benefits roll off and higher wages make work more attractive. 

Powell was masterful. He bought markets time. And he may have secured a second term. Yet as he also acknowledged, risks remain. Above all, his ability to guide markets and the economy smoothly through tapering and rate hikes depend on inflation remaining well behaved. Should higher inflation begin to change wage and price setting behaviors, no amount of clarity or ambiguity will spare Powell and the markets from a rude awakening.

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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