The key line from Powell at Wednesday's FOMC press conference was “it's kind of collapsed”, not the kind of thing you want to hear from a Fed chairman in any context .
But what was the context? A reporter asks Powell if what is driving the hawkish movement is the election but he pushes back strongly. The whole thing is worth reading:
Q: If I could follow that. You mentioned the risk of uncertainty indices about the background of the document. The upside risk of inflation jumped dramatically. The only thing, really, that happened is that you mentioned that the deflation story is still intact. However, the risk weight has jumped to the upside. The only real thing that has happened is November 5thth in the meantime. Is it fair to say that is what is driving the heightened awareness of the risk of upside inflation?
MR. POWELL: Actually, that's not the only thing that's happened. Well, what has happened is that our forecast for inflation for this year is, I think, five tenths higher than it was in September. So you have – you had two months of higher inflation, September and October. As I said, November is back on the way. But, you know, again, we – you know, we've had a year-end projection for inflation and it's kind of fallen apart as we near the end of the year. So that's definitely a big factor in people's opinion. I can tell you that probably the single biggest factor is that inflation has once again underperformed expectations.
It's still going to be, you know, between 2½ and 3. It's way below where it was. But, you know, we really want to see an improvement in inflation. You know, as I said, as we think about further cuts we are going to be looking for progress on inflation. We have been moving sideways on 12-month inflation, as the 12-month window moves. That's partly because inflation was very, very low, measured in the fourth quarter of 2023. However, going forward we're going to want to see more progress on inflation to bring it down, and maintain a strong labor market.
So what is the broader context here?
Here are the PCE inflation projections in the latest summary of economic projections:
- 2024: 2.4% → Up from 2.3%
- 2025: 2.5% → Up from 2.1%
- 2026: 2.1% → Up from 2.0%
- 2027: 2.0% → No change
It could be even worse than that with Powell yesterday indicating that the CPI numbers show 2.5% PCE (and 2.8% core) inflation.
Average PCE Inflation:
- 2024: 2.8% → Up from 2.6%
- 2025: 2.5% → Up from 2.2%
- 2026: 2.2% → Up from 2.0%
- 2027: 2.0% → No change
If you go back to September, the median PCE forecast was 2.3% on the headline and 2.6% on the core, so we're 0.2 pp above that. If you got back to this time last year, they were both at 2.4% which means that although the headline is close, the core is 0.4 pp higher than expected.
So what is the real message here?
Powell and the Fed are worried about inflation again. The emphasis has eased from the employment side of the mandate back to inflation. You can see that with an increase in Treasury yields as a result of the decision. Add in tariffs, corporate tax cuts and other potential election size and it may take some time for these concerns to go away.
In the end, I think they will because there is a strong deflationary impulse in goods and the slowdown in services (eg housing) is slowly coming through. Part of the drag is that long-term rates are now higher and 30-year fixed rates back at 7% with homebuilders getting out. That will find out eventually and that is why I would buy bonds if they can get to 5% but we are not there yet.
US 10 year yield
