Fed Chair Powell’s charm offensive touts a booming economy

Federal Reserve Chairman Jay Powell continued his charm offensive on Capitol Hill on Tuesday. 

With his usual plain-spoken and business-friendly demeanor, Powell stated, “We owe you [Congress], and the public in general, clear explanations of what we are doing and why we are doing it.”

He described the economy and labor market as very strong and noted that inflation had recently firmed toward the Fed’s 2-percent target.

Given the overall strong outlook, Chair Powell believes that “for now” optimal policy consists in “gradually raising the federal funds rate.”

The discussion that followed Chair Powell’s prepared remarks to the Senate Banking Committee was anti-climactic, with Sen. Bob Corker (R-Tenn.) quipping that “following the Fed is getting really boring these days.”

Interestingly, it may be that the Fed is intentionally fleeing the limelight at a time of more intense scrutiny. The objective may be to take the focus away from rising interest rates and a flattening yield curve and ensure a normalization of monetary policy that is as smooth as possible.

A lot to like about this economy

In his prepared comments, Powell reiterated his belief in the resilience of the U.S. economy. With real GDP set to breach the symbolic 3-percent year-over-year growth mark this summer for the first time since early 2015, the pragmatic Fed chair noted that data so far confirmed Federal Reserve expectations.

Consumer activity continues to be driven by a combination of strong labor market fundamentals, elevated confidence and reduced tax burdens amid an environment of still-low interest rates and moderate inflation.

Meanwhile, investment is supported by the trifecta of still-solid (though slowing) global activity, rising oil prices boosting energy investment and a fiscal package reducing tax obligations, increasing capital depreciation allowances and favoring some repatriation of foreign held profits.

Chair Powell highlighted the return of personal consumption expenditure (PCE) inflation to the Fed’s 2-percent target, with headline PCE inflation at 2.3 percent in May and core inflation at 2.0 percent. While noting that the Fed would continue to “keep a close eye” on inflation, he seemed to indicate a general comfort with inflation stabilizing around the symmetric objective with wage growth slowly firming.

Monetary policy: It’s not like the economy boils at 212 degrees

In a recent NPR interview, Powell stated that it was “difficult to forecast the economy” and that guiding monetary policy to maintain inflation around the Fed’s 2-percent target was an arduous job adding, “It’s not like the fact that water boils at 212 degrees; the economy doesn’t boil at 4-percent unemployment.”

In front of Congress, he emphasized a desire to continue gradually raising rates, stating that raising rates too slowly could lead to financial excesses and higher inflation, while raising rates too quickly could weaken the economic expansion.

This typical Fed speak did not decidedly tilt the balance toward expectations of three or four rate hikes in 2018. With his typical “take it as you see it” approach, Chair Powell left the door open to one or two more rate hikes this year.

He continued to highlight that Fed policy would “depend on the economic outlook, which may change as we receive new data.” Markets seem to agree with the odds of two more rate hikes this year currently hovering around 60 percent.

Flattening yield curve is not the main focus of the Fed?

When questioned about the flattening of the yield curve, Chair Powell noted that what really mattered was the neutral rate of interest — the rate at which the economy is neither restrained nor stimulated.

As some of his peers at the Fed have done, he appeared to downplay the importance of the flattening yield curve, stating his main focus was on what long-term yields indicated regarding the neutral rate.

This may be a mistake since every time the yield curve has inverted over the past 60 years, we have had a recession. Further, recent research by the San Francisco Fed clearly highlights that even in a low-interest-rate environment, “the power of the term spread to predict economic slowdowns appears intact.” Downplaying the importance of this signal will come with risks.

Rising trade tensions pose a significant risk to the economy, but not much the Fed can do

When questioned about the escalation of trade tensions globally, Chair Powell responded, “We [the Fed] stay in our lane and our lane is the economy.”

While he avoided making any direct political comment, he stated that empirical evidence shows countries promoting free-trade have higher income and productivity growth than protectionist economies.

When questioned about the direct hit to U.S. consumers, farmers and investors, Powell indicated that rising inflation and reduced exports would be “bad” for the economy.

Taking some heat from Democrats on deregulation

While most of his time on Capitol Hill wasn’t excessively stressful, Chair Powell did take some heat from Democratic lawmakers.

This was perhaps the area where Powell seemed least comfortable. He faced tough questions regarding the recent relaxation of financial regulations, and he faced particularly sharp criticism regarding the treatment of some banks in the latest Fed stress tests — two large banks were allowed to get a “conditional non-objection” grade (instead of failing) if they froze their payouts at recent levels.

Powell defended the recent stress test saying the exercise was tougher than last year, and the Fed’s conditional pass was justified. In responses to the financial deregulation criticism, he simply noted that different sized banks should be regulated differently.

The Fed remains a bastion of independence

Throughout his testimony, Chair Powell continued to stress the importance of Fed independence and transparency in a time of declining trust in public institutions.

Considering recent comments by Trump’s top economic advisor, Larry Kudlow, that the White House hopes of rates rise “very slowly,” Powell strived to display an image of the Fed focusing only on its mandates. This was very reassuring.

While current conditions are very different from those of the Nixon-Burns era in the early-1970s, we must not forget that the premise of central bank independence rests on the advantage of insulating monetary policy from short-sighted political objectives.

Indeed, while inflation expectations are currently well-anchored, history shows us that a pervasive lack of central bank independence can rapidly, and without warning, lead to rising inflation and economic instability.

Gregory Daco is the chief U.S. economist for Oxford Economics, a firm that provides research on major economies, the emerging markets, commodities, industrial sectors, global economics, global industry, cities and regions.