Jay “the inflation we caused is transitory” Powell finally did it.
On Friday, the Fed Chair finally mustered the courage to say that he is going to do the job he has been hired to do: the Fed will not “pivot” to cut interest rates until inflation slows meaningfully and persistently — even if the stock, bond and housing bear markets become much worse and the economy goes into recession.
The stock market reacted with its biggest decline in over two months, with the S&P 500 falling 3.3%.
Powell’s Speech Translated
Below we provide key quotes from, along with our honest translations:
“Today, my remarks will be shorter, my focus narrower, and my message more direct.”
This was indeed one of the shortest and clearest Fed speeches in history. Powell wanted everyone to understand, in no uncertain terms, the damage they intend to inflict on financial markets and the economy.
“The Federal Open Market Committee’s (FOMC) overarching focus right now is to bring inflation back down to our 2 percent goal. Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all. The burdens of high inflation fall heaviest on those who are least able to bear them.”
“Overarching focus” means that stock prices, housing prices, employment and economic growth are minor concerns for the Fed, compared to their goal of trying to bring inflation down from the recent +8.5% level to their arbitrary +2% level (which cuts the dollar’s value by 50% in 34 years). The dangers of inflation that Powell highlights are very real. Other dangers he didn’t mention include how the inflation they create also causes the boom and bust business cycle, destroys scarce capital resources, lowers overall living standards and increases the size and power of the government. But we can only expect so much clarity from the Fed, of course.
“Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
“Sustained period of below-trend growth” means “recession”. “Softening of labor market conditions” means “rising unemployment”. “Some pain” means “lower stock prices, lower housing prices, less wealth, more joblessness, lower living standards, more bankruptcy, more poverty and more misery”. It’s highly unusual for a politician or bureaucrat to admit they intend to cause pain, so Powell’s message should not be taken lightly.
“The U.S. economy is clearly slowing from the historically high growth rates of 2021, which reflected the reopening of the economy following the pandemic recession.”
It also reflected the incredibly irresponsible and aggressive Fed policy in response to covid, when they increased the Monetary Base by 60%, which helped increase the money supply by 40%. This caused the high and persistent inflation we have now. While the Fed likes to blame supply chain disruptions due to covid policies and the Russia-Ukraine war, there can be no widespread price inflation without an increase in the money supply. For example, if only oil rose in price due to oil supply disruptions, but the money supply didn’t change, then other prices would fall as people lower their spending in other areas. Overall prices would remain roughly the same. That is why the Fed is to blame for the highest inflation rates in 40 years.
“Inflation is running well above 2 percent, and high inflation has continued to spread through the economy. While the lower inflation readings for July are welcome, a single month’s improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.”
The Fed will not “pivot” to cutting interest rates until there are at least several months of a clear and pronounced downtrend in inflation.
“Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy. Committee participants’ most recent individual projections from the June SEP showed the median federal funds rate running slightly below 4 percent through the end of 2023. Participants will update their projections at the September meeting.”
The Federal Funds rate, which the Fed controls, is currently at 2.33%. The 2-Year Treasury rate, which the market controls, is currently at 3.37%. Historically, the Fed follows the 2-Year rate. In the past, they have had to raise the Federal Funds rate above the 2-Year Treasury rate to bring inflation down materially. That is why they are saying they expect to raise the Federal Funds rate above the current 2-Year Treasury rate by the end of 2023.
“The first lesson is that central banks can and should take responsibility for delivering low and stable inflation. Our responsibility to deliver price stability is unconditional.”
At least Powell understands what Congress thinks the Fed’s job is. According to the , “The Federal Reserve Act mandates that the Federal Reserve conduct monetary policy ‘so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.’ Even though the act lists three distinct goals of monetary policy, the Fed’s mandate for monetary policy is commonly known as the dual mandate. The reason is that an economy in which people who want to work either have a job or are likely to find one fairly quickly and in which the price level (meaning a broad measure of the price of goods and services purchased by consumers) is stable creates the conditions needed for interest rates to settle at moderate levels.” Keeping interest rates low on government debt is a key goal of Congress.
“The more inflation rose, the more people came to expect it to remain high, and they built that belief into wage and pricing decisions. As former Chairman Paul Volcker put it at the height of the Great Inflation in 1979, ‘Inflation feeds in part on itself, so part of the job of returning to a more stable and more productive economy must be to break the grip of inflationary expectations.’
Of course, inflation has just about everyone’s attention right now, which highlights a particular risk today: The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched.”
Price inflation is driven first by aggressive money creation by the Fed and banks. That is what has driven the inflation we have now. But then, as high inflation drags on, people start to reduce their demand for money as they seek value in tangible goods. That is what can ultimately lead to hyperinflation and the destruction of the currency, as has happened many times in the past, including in Germany in the 1920s. At least the Fed understands they should try to prevent that!
“That brings me to the third lesson, which is that we must keep at it until the job is done. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.
These lessons are guiding us as we use our tools to bring inflation down. We are taking forceful and rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored. We will keep at it until we are confident the job is done.”
In these last two paragraphs of the speech, Powell twice said the Fed will “keep at it” until “the job is done” of bringing inflation back down to their arbitrary +2% goal. It would be hard for him to be more clear that they will not ease monetary policy just because of declining asset prices, rising unemployment or a recession. Until inflation slows materially, the Fed intends to keep monetary policy tight.
The odds of the Fed raising the Federal Funds rate by 0.75% (instead of 0.50%) in September increased from 47% before Powell’s speech to 57% after his speech. The Fed is also doubling the pace of “quantitative tightening” (shrinking their balance sheet by selling bonds) starting in September.
Top 10 Signs A Recession Is Coming Soon
The Fed continues to say they do not expect their policies to cause a recession. But remember, they recently thought inflation was “transitory”. The Fed has a terrible track record of not only “managing” the economy, but also forecasting the economy.
Unfortunately, a recession is likely unavoidable at this point, even if the Fed started cutting interest rates right now. Keep in mind, the Fed cut interest rates all throughout the early 2000s and 2008-2009 recessions and they were unable to prevent them.
For the Fed and others who do not understand what is happening to the economy right now, here are the top 10 signs that a recession is coming soon.
1. Declining Monetary Base
The boom and bust business cycle is caused by the Fed and banks creating money out of thin air, which artificially lowers interest rates and leads to an economic boom. Eventually, money supply growth slows and interest rates rise and that leads to an economic bust.
As economist Ludwig von Mises summarized in his treatise Human Action: “The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion.”
Money supply growth has slowed from 40% last year to 4.9% in July. The Fed’s Monetary Base (currency plus bank deposits at the Fed) is currently down 9.7% from last year, as shown below. The Monetary Base will likely decline further as quantitative tightening intensifies.
2. Inverted Yield Curve
Short-term Interest rates continue to rise. As a result, the yield curve spread between the 10-Year and 2-Year Treasury rates is the most negative (or “inverted”) it has been in 22 years at -0.33%. An inverted yield curve has preceded every recession in recent decades, as shown below (with recessionary periods shaded gray).
3. Tightening Bank Lending Standards
Banks have been tightening their lending standards, which will lead to lower loan and money supply growth. As shown below, the percentage of banks that have tightened lending standards has already risen to levels only seen in prior recessions.
4. Stock Bear Market
The stock market is an excellent leading economic indicator. Every single time in the past 50 years the S&P 500 has fallen 23% over six months, there has been a recession. That happened this year, as shown below.
Stock bear markets do not end at least until the Fed starts cutting rates and, as Powell has clearly said, that is not happening any time soon.
And we’re about to enter the worst period seasonally for stocks. Many of the worst stock market declines in history have occurred in September and October, including the 1929 crash, the 1987 crash and in 2000, 2001, 2002 and 2008.
5. Housing Market Crash
Mortgage rates have doubled over the past year to 5.13%. Higher interest rates and rising prices have brought housing affordability back down to the very low levels of the housing bubble peak of 2006.
The National Association of Home Builders (NAHB) is expecting a housing recession. Their highly respected Housing Market Index recently fell for the 8th straight month to 49, below the neutral 50 level. Housing starts are down 20% since April and new home sales have fallen 30% over the past year.
Housing supply is now at 10.9 months, the highest since early 2009. As shown below, every time housing supply rises above 10 months, there has been a recession. 100% of the time.
6. Rising Initial Unemployment Claims
Employment has been the primary remaining bright spot for the economy this year. Unfortunately, employment is a lagging indicator. A good leading indicator of employment is weekly initial unemployment claims. These have been rising steadily for 5 months, as shown below.
7. Declining ECRI Weekly Leading Index
The Economic Cycle Research Institute (ECRI) is a highly regarded economic forecasting firm with one of the best track records of forecasting recessions and recoveries. As they discussed in this recent interview, they are forecasting a major global recession and they see no signs of a significant slowdown in inflation anytime soon, so the Fed is likely to keep slamming on the brakes of the economy for the foreseeable future.
Growth in their Weekly Leading Index, which usually leads the US economy by six or more months, has fallen to recessionary levels, as shown below.
8. Declining Conference Board Leading Economic Index
The Conference Board’s Leading Economic Index (LEI) has fallen 5 months in a row. As their senior director of economics said, “The US LEI declined for a fifth consecutive month in July, suggesting recession risks are rising in the near term. Consumer pessimism and equity market volatility as well as slowing labor markets, housing construction, and manufacturing new orders suggest that economic weakness will intensify and spread more broadly throughout the US economy. The Conference Board projects the US economy will not expand in the third quarter and could tip into a short but mild recession by the end of the year or early 2023.”
As shown below, the LEI’s 6-month growth rate (annualized) has fallen to recessionary levels.
9. PMI Falling Below 50
The US PMI Composite is a survey of businesses that closely tracks GDP growth, but it is much more timely. Numbers above 50 indicate expansion, while numbers below 50 indicate contraction. Therecently fell to a recessionary reading of 45.0 (July was 47.7), a 27-month low, as shown below. Regional PMIs have also fallen to recessionary levels.
10. Declining Real Manufacturing & Trade Sales
Real Manufacturing and Trade Sales are down 1.5% year-over-year. This broad measure of business sales only declines in recessions, as shown below.
Bonus Sign: Falling GDP
GDP is a very flawed and crude coincident (not leading) measure of the economy. But every single time GDP has fallen two quarters in a row, there has been a recession. That happened during the first two quarters of this year.
The Fed is being forced to aggressively tighten monetary policy in the face of an impending recession for the first time in over 40 years. The perfect storm of record high stock market valuations and Fed tightening into a recession will likely lead to the worst stock bear market and recession since the Great Depression of the 1930s, when stocks fell nearly 90%. It’s not too late to get prepared for the “pain” Powell plans to inflict.