Fedwatching: Powell on the Outlook (4 Feb 2024) and Friday's jobs report

Fed Chair Powell did a lengthy interview with 60 Minutes on Sunday. Here are my takeaways:

tl;dr - the Fed isn't going to cut in March, and Powell (like almost every other FOMC voter) will be looking closely at the employment and inflation data to decide when to begin rate cuts. His echoing of language from other FOMC speakers and emphasis on data dependency tells me that this is a Committee which is well-aligned internally on the rate path.

Interest rates rose across most of the curve from Thursday to Monday, due to a combination of Friday's strong jobs report and Powell's interview.

Rate cuts will come this year, but not soon

  • When asked if a cut is more likely or less likely in March, Powell said that "I think it's not likely that this committee will reach that level of confidence in time for the March meeting, which is in seven weeks."
  • Almost everyone on the FOMC thinks it'll be appropriate to cut this year, and inflation doesn't have to hit 2 percent exactly before rate cuts. The FOMC would move sooner if it sees weakness in the labor market or inflation persuasively coming down.
  • Regarding the criteria for beginning to cut rates, Powell repeated that he wants to see more evidence that inflation is moving sustainably down to 2%. Since the economy is strong, the FOMC can afford to wait for more good data before beginning a rate cut cycle. Powell added that the data don't have to be even as good as now, but needs to be good.
  • The interviewer got the dot plot wrong, as almost everyone does, assuming that it's a forecast of what the FOMC intends to do. The December meeting's dot plot indicated a median forecast of ~4.6% by the end of 2024. Powell said that he doesn't think any data have come out that would change anyone's assessment of the year-end rate, but everything depends on the data.

Powell doesn't think a recession is likely, despite China, CRE and geopolitics

  • The interviewer asked if the Fed's sharp rate increases starting in 2021 were "absolutely mandatory" "despite the pain they caused." Powell pointed out that despite the hiking cycle, pain hasn't really come in the form of higher unemployment, which he found surprising. He didn't really say why unemployment didn't spike, but did say that the entire current rate cycle is very unusual because of the supply and demand effects related to the pandemic.
  • Powell doesn't seem to think that a recession is imminent. When asked about slowing hiring, he said that hiring is coming down from "very, very high, unsustainably high levels" and that 165,000 jobs created per month over the past quarter is quite good. Powell echoed the language of several other FOMC speakers on the labor market "coming back into better balance" from being overheated.
  • On commercial real estate, Powell doesn't think it will lead to a real estate-led financial crisis, pointing out that the exposure to CRE on large banks' balance sheets appears to be manageable. He does expect losses in regional banks, especially as some have concentrated exposures in high-risk CRE. But he doesn't think this is going to reach 2008 levels. I don't think it will either. I do think the shift in the interest rate regime and the unrealized losses on bank balance sheets will result in reduced profitability for the entire sector over the coming decade or so.
  • Regarding China, Powell didn't seem worried about contagion from the collapse of Evergrande or generalized trouble in Chinese real estate infecting the U.S. banking system. Having done contagion analyses myself at the Fed, I can tell you that they take this type of analysis very seriously. I'm inclined to take Powell at face value on this. There isn't an obvious contagion channel to me.
  • Powell flagged geopolitics as the biggest risk to the economy at present, but said that the risks are near-term and overall estimates of global growth are going up. Everyone has been saying that geopolitics is a big risk but I'm not really seeing it. The war in Ukraine has been going on for two years and seems contained, and I don't see how it expands. If the conflict in the Middle East expands, exactly what shape would that take and what could it affect other than oil prices? If oil prices spike, I don't see the Fed hiking rates because of a non-core price change. I'm gonna go out on a limb and say that whatever economic event ends up defining 2024, it's not going to start from geopolitics, unless it's a U.S.-China brawl over Taiwan. Powell did mention "trouble, potential trouble in Asia."

Powell is pro-immigration, worried about the national debt and American leadership in the world

Powell offered a few comments on topics Fed officials rarely talk about.

  • On the topic of the national debt, Powell said "[i]n the long run, the U.S. is on an unsustainable fiscal path" and "the debt is growing faster than the economy." It's unusual for a Fed chairman to comment directly on fiscal policy, but I'm very glad Powell said this. Hopefully it registers somewhere. (I don't think it will. Human beings have a way of avoiding problems until they're unavoidable--e.g. the guy who starts exercise and eating clean after he has his first heart attack.)
  • When asked about the future of American prosperity, Powell mentioned two factors: 1) having a dynamic and flexible economy and 2) American leadership in supporting democracy and international security and economic arrangements. Not a "Fortress America" guy, it seems.
  • On the stabilization of the labor market, Powell pointed to workers returning to the labor force in 2023 as well as the resumption of immigration to pre-pandemic levels. Although he danced around comments on immigration policy, Powell said that immigrants have higher labor force participation rates (due to being younger than the population as a whole). He also said that the U.S. has benefited from immigration over time. No wonder MAGA hates him now.

A few comments on Friday's jobs report:

  • Total nonfarm employment rose by 353,000 in January, with the unemployment rate staying at 3.7%.
  • With jobs numbers this good, it's hard to make the case for rate cuts.
  • Sector-wise, professional and business services expanded by 74,000 jobs and healthcare expanded by 70,000. The "information industry" added 15,000 workers in January, but is below its November 2022 peak by 76,000 jobs.
  • This data is consistent with my impression that we did have a mini-recession in 1H 2022, focused on the technology sector, which hit a bubble peak in November 2021. The trailing effects of that are still being felt with a steady drip of tech layoffs so far this year. I think we'll also see continued failures of medium-stage startups this year who raised Series A/B money, but won't be able to close the gap to a Series C.

Subscribe to Negative Convexity

Don’t miss out on the latest issues. Sign up now to get access to the library of members-only issues.