Powell’s balancing act

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Powell’s balancing act

On Tuesday, Federal Reserve Chair Jay Powell addressed the Senate Banking Committee and House of Representatives. This is his second congressional testimony. He used the event to report on monetary policy and the current US economic condition and outlook.

Powell, appointed in February this year, has raised interest rates twice, each rise foreshadowed by concerns that the US economy would be inhibited from regaining full economic health. Investors tuned in listening for any signs the Fed may deviate from its intent to raise rates and for any snippets on possible negative effects arising from Donald Trump’s trade policy.

Powell delivered an upbeat assessment of the US economy, noting an improved job market with an average of 215,000 net new jobs created each month in the first half of this year. Unemployment, is now at 4%, near its lowest level for the past two decades. He added that core inflation of 2.3% sits just above the Fed’s target level of 2% and economic growth is pacing well from their perspective. He also referenced rising wages, improving consumer sentiment and greater employment as key contributors to a stronger economy.

Ahead of the testimony, Fed watchers were keen to find out what Powell might have to say about the recent trade wars. Trade policy lies outside the Fed’s responsibilities allowing Powell to sidestep recent questions on this hot topic. However, this time he chose to comment. He said, “Countries that have remained open to trade, that haven’t erected barriers including tariffs, have grown faster” and “had higher incomes and higher productivity”. He alluded to more protectionist countries being worse off than those open to trade. On the face of it these comments appear to contradict Trump’s controversial approach to trade negotiations and what appears to be a US retrenchment from globalisation.

Powell affirmed that gradual rate increases would continue “for now” given the supportive economic backdrop. He said it was too soon to say if trade disputes might interfere with those plans.

Powell’s carefully worded statement suggested that policy decisions are not on autopilot as many assume. They appear to signal less certainty about the Feds intended rate path towards ‘normalisation’. The so called ‘neutral rate’ is one that neither spurs nor slows growth and is considered to be a number close to 3.5%.

Chart 1: Dot plots from June’s FOMC Meeting

Source: Fed Reserve, July 2018

The dot plot graph above, used by the Federal Open Market Committee, signals each member’s forecast for the path of interest rates. This shows a determination and desire to continue to raise rates. If the dot plots prove accurate, financial conditions will tighten in response to continued strong activity levels across the economy.

History tells us that the Fed has a difficult task of managing interest rate levels in accordance with the state of the economy. If rates are increased too slowly it may lead to high inflation, which increases the cost of living for individuals; this is especially true if not supported by offsetting wage rises. Alternatively, if rates rise too quickly, the economy could weaken and inflation could run below a target level which is set to help achieve maximum employment and price stability.

The impact that ongoing trade disputes will have on inflation, monetary policy and growth is uncertain. There are few historic examples of widespread disruptions to learn from. In this regard, Powell’s balancing act has just become a little harder to handle.

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Past performance is not a guide to future performance. Tax rules can change at any time. This blog is not personal financial advice.

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