Will Powell Surprise at Jackson Hole?

For the past week, analysts have pored over the Fed’s July meeting minutes for clues about the Federal Open Market Committee’s (FOMC) thinking—particularly as it pertains to tapering quantitative easing (QE). That has many speculating about what Fed Chair Jerome Powell will say this Friday at the Kansas City Fed’s annual economic symposium at Jackson Hole, Wyoming. We suggest investors tune out the noise. Central banker chatter, regardless of the forum, doesn’t have a predetermined market reaction, and concerns about a taper are overwrought. 

The July FOMC meeting minutes added more fodder to a much-speculated topic: When will the Fed taper its monthly asset purchases? The minutes revealed mixed perspectives. “Various participants” thought a taper would make sense in the “coming months,” but “several others” thought early next year was appropriate.^[i] Though the minutes keep comments anonymous, officials’ statements in the subsequent days have led many to conclude tapering will start this year. Now many observers look to Powell at Jackson Hole for clarity.

The way pundits portray it, Jackson Hole isn’t just any conference, nor is it just the town’s famous antler arches and the Million Dollar Cowboy Bar that draw attention. No, they paint it as the place where things happen, making it one of the most-watched events on the financial calendar. The gathering’s reputation stems from former Fed head Ben Bernanke’s speeches from 2007 – 2012, particularly when he hinted at new QE programs in 2010 and 2012.^[ii] Former ECB Chief Mario Draghi laid the groundwork for his QE program in 2014 at the mountain resort, while Powell introduced the Fed’s new monetary policy framework at last year’s virtual shindig. Hence, every late-August day this year seemingly brings a new round of What Will Jay Say?

However, we don’t recommend reading into central bankers’ words, as there is a lot of evidence showing Fed words don’t necessarily mean what they seem to mean. Powell and his predecessors, including Janet Yellen, Ben Bernanke and Alan Greenspan, are fluent in a language we call “Fedspeak”—communication that is vague and non-committal by design. Fedspeak utilizes lots of squishy terms—e.g., “data-dependent” and “transitory”—to commit to nothing. Recent history shows Fedspeak is no clear roadmap of imminent action. Take official Fed guidance in 2014, which stated a fed-funds target range hike wouldn’t happen for a “considerable time” after QE ended. Yellen initially described a “considerable time” as “on the order of around six months or that type of thing.” But after those comments received a lot of press, she improved her obfuscating and deployed typical Fedspeak for the rest of the year whenever asked about an initial rate hike (which ended up being December 2015, a full 13 months after QE ended). As Greenspan famously put it, “I know you think you understand what you thought I said, but I'm not sure you realize that what you heard is not what I meant.”

The focus on the Fed chair’s words overlooks another reality: The Fed makes decisions as a committee. The chair is the most public voice, but they still have just one vote—and they can’t overrule the committee. Other voting members have their own interpretations of the data and opinions about the future. Trying to divine the Fed’s forthcoming actions based on the deliberately squishy words of multiple central bankers is a near-impossible task, in our view. Besides, if markets are at all efficient, then they are already pricing in a taper given all the recent chatter. Consider: Some analysts connected the prospect of a taper—based on July’s FOMC meeting minutes—to falling oil prices last week.^[iii] Whether that is true or not—markets can be volatile for any reason in the short term—nobody is overlooking this. If anything, an actual Fed announcement will reduce uncertainty over the timing, allowing everyone to move past it.

Besides, tapering isn’t negative. Whenever it comes to pass, it will be a welcome development, as QE is an economic sedative, in our view. By buying long-term debt through QE, the Fed lowers long-term interest rates to encourage borrowing. This reduces the spread between long- and short-term rates (which are already near zero)—resulting in a flatter yield curve. Over 100 years of economic theory and history show flat yield curves aren’t stimulus—steep ones are. Since banks’ core business is to borrow at short-term rates and lend at long-term rates, a larger gap between those rates widens banks’ net interest margins on new loans—i.e., banks have more incentive to lend since it is more profitable. That leads to faster money supply growth, which contributes to economic growth as businesses and households have more resources to deploy.

Moreover, the data debunk QE’s alleged stimulating effect. After its December 2013 announcement, the Fed started tapering in January 2014 and wrapped up its final round of bond buying in November. US GDP grew 2.3% that year and 2.7% in 2015—both swifter than 2013’s pre-taper 1.8% rate.^[iv] Forward-looking stocks seemed to anticipate this growth, too. The S&P 500 rose 32.4% in 2013 and a solid 13.7% in 2014.^[v] Though 2015 returns were just 1.4%, we think that had more to do with a global market correction that stemmed from China-related fears and weak oil prices tied to a glut than US QE developments.^[vi]

Jackson Hole may be the center of pundits’ universe this week but unless you are really interested in this year’s theme of “Macroeconomic Policy in an Uneven Economy,”^[vii] feel free to tune down the volume. More often than not, Jackson Hole is boring.^[viii] Thinking markets are waiting with bated breath for Powell’s speech falls into the trap of thinking the Fed is all-powerful—a big misperception, in our view.