Main Street Macro: Casting for bigger fish in Jackson Hole

So, are you cutting rates or not?

Federal Reserve Chair Jerome Powell has probably been asked this question more times in the last six months than any Fed chair in the last 20 years. The last time benchmark rates were this high was early 2001.

But rate cuts won’t be the most pressing question for Powell or other Fed members this week when they gather in scenic Jackson Hole, Wyoming. This annual convocation of roughly 120 high-profile academics, global policymakers, and business leaders has another mission entirely.

This year, in a location known for its fly fishing, the Fed will be casting for fish bigger than the timing of its next rate cut.

The agenda at this year’s Jackson Hole Economic Policy Symposium includes discussion on an overarching issue: Reassessing the Effectiveness and Transmission of Monetary Policy. In plain English, attendees will weigh how the economy reacts, or doesn’t react, to Fed rate decisions.

It’s an important topic, one that will give Fed policymakers an opportunity to polish the central bank’s brand as a strategic steward of price stability and full employment. Here’s how.  

Rewarding patience

Last week’s economic data could have not broken better as a prelude to Jackson Hole. After a topsy-turvy two weeks, steadfast central bank policymakers were rewarded with an abundance of good news when three big macroeconomic watch points—inflation, the labor market, and consumer spending—all came out strong.

Initial jobless claims, a measure of layoffs, dropped to a five-week low. The Consumer Price Index fell to 2.9 percent, the lowest level in more than three years. And July retail sales exceeded expectations, signaling that consumers are still in good shape as the primary drivers of economic growth.

Confronted with this upbeat data, Wall Street shook off the recession fears that had caused wild market swings just a few days earlier, and again embraced the possibility that the Fed had indeed engineered a soft landing for the economy.

Focusing on the long term

Last week’s data wasn’t all good. One area of the economy that’s been particularly resistant to the Fed’s policy charm is housing.

The July CPI measure of shelter costs, which estimates the monthly cost of renting, rebounded to a 0.4 percent increase month over month, erasing a drop in June. Shelter costs composed 90 percent of the monthly increase in inflation, according to the Bureau of Labor Statistics.

Housing inflation can’t be slowed by interest rates alone. It requires an increase in affordable inventory, which appears to be waning. Census data on housing starts shows residential construction down 16 percent from last year.

Housing isn’t the only problem that rate cuts won’t solve. Demographics and globalization, once disinflationary forces, have grown less effective in tamping down price growth. Periodic bouts of inflation are likely to be more common in the future. 

At Jackson Hole, it would behoove the Fed to remind market participants that they’re in it for the long haul, not just for hotly anticipated rate cuts in September.

Reframing the discussion

In Jackson Hole, Powell will have the opportunity to address several open questions in his highly anticipated remarks.

For example, the central bank’s current monetary framework was adopted when the Fed was trying to solve for too-low inflation. Do policymakers need to change their target inflation comfort zone?

Another open question is when the Fed should employ quantitative easing, the central bank’s big-scale purchases of bonds and other financial assets, to help drive interest rates down. What’s the best way to reverse those moves—to employ quantitative tightening—when they’re no longer needed?

Finally, it’s critical for Fed policymakers to provide context on the new normal. Main Street and Wall Street have become accustomed to rock-bottom interest rates and record-low unemployment, both of which can’t be sustained. The Fed should take the lead in defining what constitutes normal for benchmarks in a healthy U.S. economy.

My Take

In 2022, the Jackson Hole conversation turned to the new potential for higher-for-longer inflation and interest rates in the wake of the pandemic. In 2023, the discussion centered on permanent changes to the structure of the global economy caused by the pandemic.

As in previous years, thisyear’s symposium is likely to generate more hard questions than easy answers.But it’s also chance for reinvention.

For the past three years, market-watchers have criticized the Fed for being late to recognize the pandemic’s inflation threat, and late to cut rates as that threat receded.

But the recent run of good economic data has turned this year’s Jackson Hole conference into a chance at redemption, of sorts, for the data-dependent central bank. At this critical economic juncture, it’s a chance for the Fed to refresh its reputation as a central bank that’s not behind the curve, but in front of it.

I’ll be in Jackson Hole this week, and Main Street Macro will be on hiatus until Sept. 9.

The Week Ahead

Wednesday: Fed meeting minutes from July will provide clues to policymakers’ thinking on the state of the economy and the need for rate cuts.

Thursday: We’ll get signals on the current state of manufacturing and services providers and their hiring plans from the S&P Global flash PMI survey.

Existing home sales data from the National Association of Realtors will give us a read on how the summer selling season it progressing after getting a boost from slightly higher inventory and slightly lower mortgage rates.

Friday: The eyes and ears of all economists, including mine, will be tuned into Powell’s speech from the Jackson Hole. Just bear in mind that whatever he talks about, he won’t tell us when the Fed will cut rates. That’s a question for next month.