Powell’s comments weren’t that different from Clarida

Really quick here. The Powell speech is over and the stock market is up on the back of it because people interpreted his comments as dovish. Was it though? It depends on where you’re coming from.

If you thought the Fed had been signaling four rate hikes through the end of 2019 and that it was actually going to stick to that plan, then yes, this was a dovish speech. But that’s not the right way to look at it, because since October, acceleration has been off the table. We know that the economy is likely to slow in 2019. And given recent Fed policy statements, the only question was whether that slowing would cause the Fed to pause.

What Powell said

I don’t see a lot here that differs from Clarida yesterday, frankly. Take a look:

  • Bullish US economic data, bullish jobs data, caution about inflation accelerating (check, check, check): “Congress assigned the Federal Reserve the job of promoting maximum employment and price stability. I am pleased to say that our economy is now close to both of those objectives. The unemployment rate is 3.7 percent, a 49-year low, and many other measures of labor market strength are at or near historic bests. Inflation is near our 2 percent target. The economy is growing at an annual rate of about 3 percent, well above most estimates of its longer-run trend.”

Even his conclusion was the exact same as Clarida: “Our gradual pace of raising interest rates has been an exercise in balancing risks.  We know that moving too fast would risk shortening the expansion. We also know that moving too slowly–keeping interest rates too low for too long–could risk other distortions in the form of higher inflation or destabilizing financial imbalances. Our path of gradual increases has been designed to balance these two risks, both of which we must take seriously.”

Where are the risks to Fed hikes?

And what Powell did say about financial stability wasn’t very dovish.

Compared with other economies, lending and borrowing in the United States depend less on bank loans and more on funds flowing through a wide array of capital market channels. The crisis revealed that this capital market centric system, despite its many benefits, also provides more places where systemic risks can emerge…Innovation and risk-taking contribute to the dynamism of our financial system and our economy. As Hyman Minsky emphasized, along with the many benefits of dynamism comes the reality that the financial system will sometimes evolve toward excess and dangerous imbalances.

This reality underscores the vital importance of the second part of post-crisis reform: monitoring for emerging vulnerabilities.”

When Powell looked around at vulnerabilities, he didn’t see a lot of them, not in bank leverage, not in funding risk, and not in household balance sheets. The only thing he could point to was non-financial business leverage. And that IS where the risks are. But look at what he said:

For now, my view is that such losses are unlikely to pose a threat to the safety and soundness of the institutions at the core of the system and, instead, are likely to fall on investors in vehicles like collateralized loan obligations with stable funding that present little threat of damaging fire sales. Of course, we will continue to monitor developments in this sector carefully.

Basically, a nothing burger

And what about bubbles?

Looking across the landscape of major asset classes, we see some classes for which valuations seem high relative to history…We see no major asset class, however, where valuations appear far in excess of standard benchmarks as some did, for example, in the late 1990s dot-com boom or the pre-crisis credit boom.

…From the financial stability perspective… today we do not see dangerous excesses in the stock market. Another nothing burger

He even writes it as a headline: “Bottom Line: Financial Stability Risks Are Moderate”

That basically means the Fed thinks it could keep hiking and none of these risks are large enough to create the pre-conditions of crisis.

My view

The Fed is going to continue to talk about hiking in December and then three times in 2019. That forward guidance won’t change any time soon. What will change are the data. And the Fed is dependent on that to guide policy going forward.

Right now, things are good. But I believe the credit cycle has just turned down. That’s negative for growth in 2019 and could mean the Fed’s forecasts are too optimistic. Based on current trends, I think there is a high likelihood the Fed doesn’t get to three rate hikes in 2019. December and March are ‘in the bag’. But, beyond that, it’s wide open. That’s my interpretation of Clarida. And, having seen what Powell had to say, that’s my interpretation of him as well.

So, if you thought the Fed was going to hike 4 times this coming year, maybe this was a dovish speech. But, if you though the Fed was data dependent and the data has been softening, this speech was in line with expectations.

P.S. – Remember, data dependence works in both directions: a terrible holiday season puts the Fed on hold past March. But a gangbusters holiday season keeps all four hikes on the table and even raises the spectre of a fifth. That means the upcoming data are very important for this credit cycle.

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