Fed Chair Powell’s 1970s Lesson Casts Doubt On Quick Pivot; S&P 500 Falls


Federal Reserve chief Jerome Powell said in his much-anticipated address in Jackson Hole, Wyo., on Friday, that policymakers should not be wary too early or risk high inflation becoming entrenched. After the transcript was released, the S&P 500 fell sharply.


“Restoring price stability will probably require a restrictive policy to be maintained for some time,” Powell said. “The historical record strongly warns against premature easing of the policy.”

Powell said curbing inflation will require “a sustained period of below-trend growth” for the US economy. He acknowledged that tightening the Fed’s policy “will hurt households and businesses.” But “much greater pain” would come from failing to restore price stability.

The big question ahead of Powell’s speech was whether he would try to undo the mild impression he made with his July 27 press conference. Those comments helped the S&P 500 rise a whopping 18% from its June 16 low, exiting a bear market.

In the near term, markets are focused on whether the Fed will raise 50 or 75 basis points on September 21. The odds shifted slightly in favor of a smaller step with the release of soft inflation data for July ahead of Powell’s speech. The Fed chairman, who suspended forward guidance at his July 27 press conference, took no sides on the size of the next rate hike. But the odds leaned back toward a third straight 75 basis point rise after Powell spoke.

When will Fed Pivot run?

The medium-term outlook for Fed policy is particularly strong for investors’ risk appetite. The S&P 500 rally has been built at least in part in hopes that the Fed will stop raising rates in early 2023 and begin considering cutting rates by mid-year.

A report that the Fed could keep rates “high for longer,” as James Bullard, president of the St. Louis Fed, recently said, was the last message investors wanted to hear from Powell. The Fed chairman didn’t use those words exactly. But he delved into the history of the Fed’s failures in the 1970s, illustrating the risk that rate hikes would be reversed too soon. Today’s policy makers clearly hold that experience in high esteem.

The takeaway: Even if the economy slides into recession, the Fed may be slow to cut its benchmark rate — a sharp break from how monetary policy has been conducted in decades of disinflation.

Inflation is declining

Powell’s speech came as the Fed’s favorite inflation gauge showed that price pressures were easing. The consumer spending price index fell 0.1% in July, pushing annual inflation down from 6.8% in June to 6.3%.

Core prices rose 0.1% from June, while core inflation fell to 4.6%, the lowest since October.

Inflation is clearly falling from its peak, with energy prices falling and supply chains recovering. It is unknown to what extent strong wage growth and steep rent increases will keep inflation above the Fed’s 2% target.

Powell noted the lower inflation data for July. But he added that “one month’s improvement is not nearly enough” of what the Fed needs to be confident that inflation is falling enough to interrupt rate hikes.

Federal Reserve History Lesson

In a remarkable speech on March 21, Powell took a walk through the history of the Fed’s soft landings to back up his claim that the current tightening could produce a similar outcome. Powell cited 1965, 1984 and 1994 as proof that the Fed tightening does not have to lead to a recession.

He also mentioned the tightening of the Federal Reserve from 2015 to 2019 to bolster his case. And while a recession followed in 2020, it was Covid – not the Fed – that was to blame.

Federal Reserve meeting minutes reduce chance of major interest rate hike

Some economists expected Powell to give a somewhat less uplifting history lesson in Jackson Hole. Nomura economists Aichi Amemiya and Robert Dent wrote in their preview that Powell’s speech “could put an emphasis on the experience of the 1970s.”

“A number of Fed participants have recently pointed to that era with some caution, mostly to emphasize their preference to avoid a ‘stop and go’ tightening path,” they wrote.

Fed ‘Stronger for Longer’?

Unlike just before the pandemic, the last time the unemployment rate was as low as 3.5% was in 1969. The Fed responded by raising its key interest rate to 9% to try to short-circuit a bout of wage-related inflation.

However, in 1970, the Fed reversed course. In early 1971, the Fed cut interest rates to less than 4%. That helped push the unemployment rate up to 6%. But it “wasn’t high enough to dampen wage pressures,” Jefferies chief economist Aneta Markowska wrote in a June 3 note.

“The Fed has not created enough slack to curb inflation and stabilize inflation expectations,” she wrote. “Policymakers repeated the same mistake in the mid-1970s, when they stepped aggressively and sparked another recession, but then eased too quickly and reinflated inflationary pressures.”

The lesson, according to Markowska: “If the Fed is faced with a price-wage feedback loop, it needs to stay stricter for longer.”

Powell’s take on the 1970s

“During the 1970s, as inflation rose, anticipating high inflation became entrenched in the economic decision-making of households and businesses,” Powell said. “The more inflation rose, the more people expected it to remain high, and they built that belief in wage and price decisions.”

Then-Fed Chairman Paul Volcker finally managed to break through inflation in the early 1980s after “several failed attempts to lower inflation over the past 15 years,” Powell said. “Our goal is to prevent that outcome by acting decisively now.”

Relaxing financial conditions

Powell’s message may have been a wake-up call for financial markets, which were already anticipating a reversal in Fed tightening. That view of rate cuts in 2023 has led to an easing of financial conditions, reflected in lower market interest rates and a higher S&P 500, Dow Jones Industrial Average and Nasdaq.

Minutes from the July 26-27 meeting of the Federal Reserve indicated a “significant risk” that “increased inflation could be anchored if the public questions the committee’s decision to adjust policy stance sufficiently.”

The minutes said: “If this risk materialized, it would complicate the task of bringing inflation back to 2% and significantly increase the economic cost of doing so.”

CPI inflation finally falls – much more than expected

To address this risk – that recent easing in financial conditions will keep inflation higher than usual – some economists have said Powell may want to raise more doubts that a Fed-turned-rate cut will soon be forthcoming.

S&P 500 Responds to Powell’s Speech

During Friday’s stock market action, the S&P 500 moved sharply lower in a volatile fashion as investors digested Powell’s speech. The S&P 500 fell 1.9%, the Nasdaq 2.4% and the Dow Jones 1.5% in late morning trading.

Through Thursday’s close, the S&P 500 is 12.5% ​​lower than its closing record on January 3, but is up 14.5% since June 16. low on June 17. The Nasdaq remains 21.3% below its all-time high, after rising 18.7% from its June low.

Be sure to read IBD’s The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.

Follow Jed Graham on Twitter @IBD_JGraham to cover economic policy and financial markets.


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The Valley Voice
The Valley Voicehttp://thevalleyvoice.org
Christopher Brito is a social media producer and trending writer for The Valley Voice, with a focus on sports and stories related to race and culture.


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