Pity poor Jerome Powell. He just can’t seem to stay out of his own way.
For the past several weeks the Federal Reserve chair has been promising – ok, maybe not promising, but strongly “indicating” – that it’s only a matter of time that the Fed will cut interest rates. He’s certainly been grooming the financial markets for such a move, and the markets have duly responded, as the major U.S. equity indexes all jumped more than 7% last month while bond yields plunged.
Now comes last Friday’s jobs report that came in much stronger than most people expected and far stronger than the previous month’s totals. The Labor Department said the economy added 224,000 new jobs in June, well above not only the consensus Street forecast of 165,000 but also the most bullish individual estimate of 205,000. It was also far stronger than May’s total of 72,000, which was actually revised downward by 3,000 from the original figure.
Following May’s underwhelming report, most people seemed to believe that the jobs boom had finally played itself out, and it would be all downhill from here, with a recession looming in the not-too-distant future. And then what do you know, the June report comes out and takes everyone by surprise, not least of all Jay Powell himself.
This is certainly not the first time that the Fed has been caught unawares of what is actually happening in the U.S. economy. I don’t know how many times over the past 10 years the Fed has prepped the market for an interest rate move only to have its basis for doing so blown out of the water by a subsequent economic report that showed that the Fed’s thinking was totally off base.
While we can’t expect the Fed to be able to predict the future, it should certainly have a better idea than everyone else where the economy is at any given moment. You would think the Fed is privy to every economic data point the government collects, supplemented by its own army of data collectors and analysts. How did it fail to see how strong the jobs market – and by extension, the entire economy – is before last Friday’s report came out? It’s as if all the numbers started to pour in and at the last minute, surprise, the nonfarm payrolls number landed in our lap.
It’s one thing for an economist at a major bank or financial institution to guesstimate wrong since they don’t have access to all the government numbers. What’s the Fed’s excuse?
And what does it do about it now?
Yes, Powell tried to backpedal some after the Fed’s June monetary policy meeting, when he said: “the case for somewhat more accommodative policy has strengthened.” He, and several of his Fed colleagues, subsequently tried to put the genie back in the bottle by saying the usual stuff about the Fed not having made up its mind yet about future interest rate policy. While that may very well be true, it has raised investor expectations that a cut is coming, and now if it doesn’t deliver, we can probably expect another market tantrum.
Late last year, if you remember, something similar happened. The Fed for several months had primed the markets to believe that it was going to raise the federal funds rate at its December meeting in light of the strength of the economy in the second and third quarter, when GDP grew by 3.4% and 4.2%, respectively. In the meantime, however, the economy had started to soften, with fourth-quarter GDP eventually falling to an annualized growth rate of 2.2%. But by the time the meeting came around, the Fed felt it had to stick to the rate-rise plan. If it had done a 180 and either done nothing or actually lowered rates, the markets might have gone bananas, thinking that the economy must be in a lot worse shape than anyone suspected.
Now the opposite seems to be going on. The Fed believes and is telling the markets, that the economy is losing steam and that it will lower rates to keep the momentum going. Only now the jobs report is signaling that that thesis may not be accurate.
Of course, the Fed has only itself to blame for this state of affairs. For the past six months or longer, the Fed has allowed itself to be pressured into a more accommodative monetary policy by the White House and Wall Street even though the underlying economy may not warrant such a posture.
How will the Fed extricate itself from this predicament? Powell is scheduled to deliver his semiannual testimony to Congress on Wednesday and Thursday. Hopefully, we’ll find out more then.
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