Will the Fed Continue to Embrace a Longer-Term Hawkish Stance?

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0:38Good afternoon, everyone, and welcome to this edition of the Deep Dye interview series here at Real Vision. My name is Andreas Steno. I'm the senior host here at Real Vision, and we send to you live, hot on the heels of the Jackson Hole conference in Wyoming this weekend. We're in tremendous company this afternoon to assess the outlook for the Fed Reserve after this conference. First of all, it is my utmost pleasure to welcome Dennis Lockhart, former member of the Federal Reserve Market Committee. and former president of the Federal Reserve Bank of Atlanta. It's a pleasure to host you, Mr. Lockhart.

1:12Thank you, Andreas. Good to be with you. And secondly, we also have the tremendous Danielle DiMartino Booth of QI Research with us again on the platform. Always a great pleasure to host you, Danielle. And you're one of the very best watchers of the Fed out there. So thank you for joining us. Good to be with you again. Thank you for having me. Guys, first of all, we're recording hot on the heels on this Jackson Hole conference. I'd like to start with you, Mr. Lockhart. How important is this Jackson Hole Conference to the Federal Open Market Committee team? Well, it's potentially important because it gives the chair every year an opportunity to provide some more guidance, if that's the desire, or to at least say something important.

1:56Sometimes the chair chooses to talk on a different subject and not necessarily provide a lot of information, but it is an opportunity to clarify the thinking of the committee. I think it's important to emphasize that the chair is speaking for the committee. He would not probably get too far outside a consensus of the committee. So did he say anything of importance in your view, Mr. Lockhart, over the past weekend here? Certainly said a lot of things of importance, but I would say that there was not a lot of new information in this speech. He repeated and reinforced many of the themes that we've heard before.

2:41and in terms of concrete guidance, I think for the most part, he was noncommittal. Danielle, I'd like to bring in your opinion on the Jackson Hole conference as well. What made the biggest impression on you from Powell's speech during the Jackson Hole conference here? Well, I think my biggest takeaway, I had two big takeaways. The first of which was 2 % is not going anywhere. So there had been some rather loud advocacy to raising the inflation target to 3%. And he was very pointed and resolute in saying that until the job is done entails the number two and not three. Do I really think he'll split hairs if it's very glaringly obvious that they're getting close to that 2 % target?

3:36No, I don't. But what he did refuse was any idea that some have pressed him on about raising the inflation target and hats off to him for that. And my other biggest takeaway was that there was absolutely no mention of the balance sheet. And there is an active balance sheet policy going on as Chair Powell wishes for it to be in the background. But every Friday afternoon after the market closes, the Fed releases its weekly H8 report, and it shows that other deposits at U.S. Commercial Bank on their liability side have really dwindled down to a record low level. The pace has accelerated since the debt ceiling was resolved, and we've seen that manifest late July into August in a large pickup in company bankruptcies and in firm closures.

4:31So there is a liquidity lever that's being utilized at the Federal Reserve, but nobody really talks about it. And I think that that suits Chair Powell. I'd like to bring in you, Mr. Lockhart, on this topic of the balance sheet as well, because I think Janet Yellen famously said that bringing down the size of the balance sheet is as boring as to watch paint dry. So how important is the balance sheet policy for the overall tightness of monetary policy in your view? There have been a lot of academic studies on that question and how many basis points X amount of balance sheet shrinkage amounts to.

5:10In my experience, at least, nobody came up with an absolutely conclusive number. It's an important policy because I think the committee feels they simply have to get the balance sheet down. And what I find interesting in the most recent discussion, although it did not come up in Powell's speech last Friday, is the notion that was actually put forth first by Lori Logan of the Dallas Fed, that they might continue to shrink the balance sheet even after starting rate cuts, meaning two tools of policy are arguably going in opposite directions. That discussion has continued, and it was actually in the last minutes of the July meeting.

6:00So it's an interesting development that they feel so strongly about the balance sheet that they wouldn't pause that program if they began to cut rates. Daniel, how do you rank the interest rate policy, the Fed funds policy versus the balance sheet policy in terms of repercussions for the economy and financial markets? Well, I think right now the idea of persistence in a tight stance, if we're talking about at some point in 2024, because there's still about a 50 % probability that before 2023 is out that we will see one more 25 basis point rate hike. But I think that given where rates are right now on an absolute level, that at the margin, that small of another rate hike is really not going to make that much of a difference.

6:50What will to companies that need to borrow? There was a furniture manufacturer in North Carolina that on Saturday simply announced these three factories are closing. Everybody who's working remotely need not show up at work on Monday. And the entire company just vanished overnight into liquidation. And the reason was they couldn't secure the financing. So the longer that Powell is able to maintain a higher level of rates relative to what preceded, which was, I mean, let's get real, zero interest rate policy or having extremely low interest rates was something that existed for a generation at the Fed.

7:29But the longer that higher actual rates persist, I think the more difficult it's going to be, the higher ramping up we're going to see in the default rate cycle. But if I could dovetail onto something that Dennis just mentioned, it would be that there is a silver lining in theory if the Fed starts to lower interest rates while it continues to reduce the size of its balance sheet. And that's that they're very far behind in terms of the pace at which they want it to reduce their mortgage-backed securities holdings. And if, in theory, you could take that level of interest rates down by a percentage point or two percentage points or two and a half percentage points, that's how much Powell used the last time.

8:09He started lowering interest rates before he got to the zero bound. Of course, he could stop at a higher level than before. I think that that is that is mana to the gods of central banks. The idea that they've got enough latitude to not return to the zero bound. I think that that makes central bankers inherently more independent. But if they can bring rates down enough to accelerate prepayment speeds, even if they do stop reducing their treasury holdings, they can certainly begin to play a little bit of catch up with reducing the size of that mortgage-backed securities portfolio. That's a very good point, Daniel.

8:42Dennis, if we look at Powell's rhetoric in this speech at Jackson Hole, he used the phrase risk management considerations quite a few times during the speech. And to me, this is sort of him trying to balance the risks of overdoing it versus the risks of underdoing it versus the inflation target. So how do you read the choice of words when he starts talking about risk management related to monetary policy? Well, the way that term is used is really to suggest that they'll be extremely attentive to any signals in the economy that the policy has created problems that are costly. And having said that, I think this committee believes that the costs of an overshoot, given that they can correct that relatively quickly, are probably less than the costs of undershooting and ending up in a stop-start pattern.

9:49And that particularly creates turmoil in financial conditions and creates a lot of ripple effects through the economy. But overall, the term risk management means that they're making decisions meeting by meeting. That's something we've heard before. And it's going to be based on the data. And as they read the data, they'll decide what they're going to do. And they'll be very careful as they go along. And I thought that was one of the themes of his speech. We're going to take a quick break and be right back with more of today's top analysis on the Real Vision Daily Briefing.

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11:29Danielle, was this speech the sort of ultimate end to forward guidance? There is no forward guidance left, right? I would completely concur with what Dennis just said. I think they're trying to communicate that they don't want to guide you forward, that they truly want to be data dependent. We're at such a fragile juncture here. We're starting to see the layoff cycle pick up. We've got 48 of the 51 states with rising continuing jobless claims. That means that they have to be very nimble for an unemployment rate shock at this juncture, even though the unemployment rate remains at the lowest since May of 1969.

12:10But the word that Dennis chose to use, attentive, that's really where they need to be right now because so few of the macroeconomic indicators that would have otherwise reacted by now to monetary policy, the delta from zero to where we are now. So few have reacted in part because there's this massive fiscal offset and money that the federal government has continued to place into the U.S. economy such that there are so many moving pieces. The Fed needs to have no forward guidance and the Fed needs to be nimble and indeed attentive to the data as they're released. Mr. Lockhart, I'd like to ask you about the nowcast model of Atlanta Fed.

13:01I know you're the former president of, say, Atlanta Fed, and the nowcast model of Atlanta Fed currently suggests that the economy is running extremely hot during the third quarter. What's your assessment of the growth temperature right now as we speak in the U.S. economy? Well, first, let me explain what that now cast is. It's basically the accumulation of data that mimics the calculation of a GDP report, and it's done for the current quarter. and there's no human judgment involved. It's just that as the data come in, they're put into an algorithm and they calculate sort of a run rate, what the quarter is looking like.

13:44For the reasons that early in a quarter, you don't have much data, I don't pay any attention to it until I get to the midpoint of the quarter. We're now past the midpoint of the quarter. And in the last month of the quarter, in this case, September, you can begin to take the number seriously. The last time I looked, the number was 5.8 % annualized growth in the third quarter. And that tells me that the economy, the impulse in the economy is very strong, growth impulse. And even if it were half of 5.8%, it would still be a pretty strongly growing above trend growth rate in the broad economy. And that is, to some degree, frustrating, I think, the committee, because they continue to believe, and probably correctly, that they're going to have to slow the economy to get the inflation rate down to 2%.

14:50Danielle, I typically love your outspoken nature, so I'd like to ask you about this nowcast model of the Atlanta Fed as well. Do you find it fair to assume that the U.S. economy is currently growing above trend? So this is a pretty difficult question for me, and I do follow more than one of the nowcasts. Of course, the St. Louis Fed is at 0.46 right now. So the delta between those two is quite wide. A gentleman by the name of Ben Hurzon, originally at Macroeconomic Advisors, which was then bought out by IHS Market, which was subsequently bought out by S &P Global, he pretty much invented the GDP model on the sell side.

15:36And so everybody who is in my old world of sell side investment banks has kind of followed Ben's model. And so I tend to stick with Ben and where he is. He meticulously follows every single things that you would never find on the Bloomberg economic calendar. He incorporates them all into his model. Right now, he's about 2.3 percent for the third quarter or for his third quarter estimate. And a lot of that has to do with assumptions about inventory rebuilding going into the third quarter because de-stocking has been so much more aggressive than what a lot of models had been assuming as inputs. So very fluid right now.

16:19And we have to bear in mind, again, one program of the federal government has pumped$300 billion in cash into the pockets of high net worth individuals in the last 12 months. that that's a lot of money. There's still a lot of stimulus that is going on, and it helps explain why higher end consumption through the University of Michigan, as well as the wealth effect of a stock market that is highly resilient, is powering the consumption of the top quintile earners of the nation who are responsible for 40 percent of spending. That one little cohort is 7 % of global GDP. And right now they really are enjoying a robust gains in their home prices, robust gains in their stock market portfolios, in addition to being on the receiving end of a massive stimulus program, care of Uncle Sam.

17:09So lots of moving pieces. But again, you get the sensation that something at some point is going to give unless all of these companies going away, vanishing, going bankrupt, absolutely have no macroeconomic impact, which that's hard for me to see. Mr. Lockhart, given your experience in the committee, what are the pros and cons of signaling a rate hike pause now? The market has sort of sniffed out this pause. If you look at the market pricing, we're at least close to the peak now. So what are the pros and cons of actually explicitly signaling such a pause, say, in the quarters ahead? Well, first, let me say, I don't think I heard a pause signal, frankly.

17:53I thought Powell was noncommittal. I thought he said effectively, we don't know yet what we're going to do in future meetings because we don't know what the data is that's going to guide us in future meetings. We may have to raise rates further because this economy is running hot or strong. And I think that's what the committee believes is going on. but we may not because there are a lot of other factors at work. And so I didn't hear a pause. I do think maybe a skip is in the cards simply because they increased in July. They're sort of on a pace of every other meeting. So it would be very convenient in September to just continue with that pace.

18:39It buys them another few weeks to size up what needs to be done. But let me come back to the point. I read the speech word for word. I taped it and listened to it. I didn't hear any indication of a pause, meaning several meetings of no policy action. Dennis, as far as I remember, you entered the committee in March 2007, right around the pause ahead of the great financial crisis. Does anything around the current outlook feel reminiscent to you of the 2007 outlook where the Federal Reserve decided to pause interest rate hike for a prolonged period of time? Well, my memory of the history, and my memory is pretty vivid because it was pretty exciting times to be on the Federal Open Market Committee, is that we had actually started at a Fed funds rate of over 5 % and had started the process in 2007 of bringing it down, accelerated that at the beginning of 2008, and reached the zero bound in December of 2008 in a steady march downward in response to the financial crisis.

19:58I think these circumstances are quite different from that. And if you want to call the decline in rates a pause in increasing rates, that is what it was. But it really was a march to zero that took place from late 2007 through the calendar year 2008. Daniel, I'd like your take on the question of pros and cons of actually pausing interest rate hikes here. You mentioned the liquidity issues facing U.S. corporates. But what do you make of this question of pausing here? Is it feasible to pause here from an economic perspective? Well, as Dennis describes it, and Tom Honig and his successor, Esther George, she wrote a very good paper at the Fed last year before she retired.

20:53And I think advocating for there to be a wider cadence in between rate hikes is perfectly legitimate and should not signal to the market. And in fact, if you look out again between now and the end of 2023, so we're talking about the potential for the November or the December F1s, December typically very unusual to raise rates. That's why I think your probabilities are stacked at that November meeting. But that's when you have the highest probability for another quarter point hike. Now, it's this whole separate question if you're getting into money supply and if you're getting into liquidity issues.

21:29Because, again, even though they're parallel policy levers, one certainly does affect the other. And, of course, the balance sheet shrinkage, it's a great mystery because we don't know on the aftermath of central bank balance sheets globally going from$5 to$25 trillion, what it's going to take in terms of liquidity depletion to have the same effect as that which brought about the events 2018 into 2019. It's a decidedly different backdrop. We've seen global central bank balance sheets decrease by$3 trillion, but we certainly haven't seen any kind of systemic risk start to become unleashed as we did when the Fed had to stop in with their not QE measures, stopgap measures a few years back.

22:21Mr. Lockhart, I'd like to bring your expertise in on this topic of the inflation target in the US. Some pondered ahead of the Jackson Hole Conference that the inflation target could be up for debate. Whether 2 % is the right target after After all, it's obviously something that can be debated or can be discussed. Is it something you find relevant for the outlook for the Federal Reserve, say, over the next five to ten years, whether 2 % is the right target variable or not? Well, as has already been mentioned, Chair Powell took it off the table pretty conclusively, I think. and that has been what my view of the subject that it's the two percent target is not going to be adjusted because of economic circumstances that could be transitory or they could be more structural in nature that's not to say that the issue won't be discussed again it's not to say that that with a new chair at some point you might not find it raised as a question but But for this Fed, the Powell Fed, I don't believe you're going to see any change in the target per se.

23:43Now, some of the members of the committee can very well talk more in a range and therefore add a little bit above 2 % as being in an acceptable zone. And I think you may see that in the rhetoric of some of the committee members. But as an official inflation target of the U.S. central bank, it is 2 % and I don't see it changing. We're going to take another quick break and be right back with more of today's top analysis on the Real Vision Daily Briefing.

24:17If we look at the details of the current inflation in the U.S., if we set aside shelter costs, Inflation is actually running very close to zero, both in CPI terms and in the official inflation target PCE terms. So what do you make of that, Dennis Lockhart? Is it relevant to look at inflation outside of housing, given the leads and lags in housing space relative to inflation pressures? You know, this gets at a question of what is it that they are actually looking at when they're talking about inflation. And I do find it, even when I was a policymaker, found it to be a somewhat frustrating discussion because they're really trying to get a sense of the underlying, very broad inflationary or disinflationary bias in the economy.

25:14And that underlying inflation rate is sort of an elusive concept in some respect. You cannot get at it by just looking at core PCE, for example, or headline CPI or any single indicator. You only get at it by looking at a dashboard, which might have 20 to 25 different indicators or cuts of the most recent inflation data. And then you have to deal with the question of month-to-month noise and transitory elements that are in the inflation picture. So determining that underlying picture is not easy. It's difficult, and different members of the committee may approach that differently. Having said all that, I think the committee believes that the underlying inflationary pressures broadly, that includes goods and includes shelter as well as non-shelter services, still are elevated and still are well above where they want it to be, something that resembles 2%.

26:24So I think that's the important thing, what the committee believes to be the situation. Danielle, what's your take on this discussion on the inflation target and also the subcomponents of the inflation measure? Do you find shelter to be a relevant part of the inflation basket? And do you think the Federal Open Market Committee will be willing to discuss this inflation target of 2 %?

26:51I concur with Dennis. I don't think that this Federal Reserve is, I don't think that the 2 % versus 3 % discussion is on the table the same way I don't think a central bank digital currency is on the table for this Fed. There are just certain things, or climate change, for example, there are just certain things that you can tell that philosophically Jay Powell's not on his watch. They're not going to be subjects that are brought up on his watch. I do happen, however, to think that shelter should definitely go into the construct of thinking, because when you think of shelter, there are so many different other aspects of inflation inputs that are affected by whether or not there's dynamism and movement in the market from one home to another or from one apartment to another.

27:37So it is a good 40 percent of the CPI. I completely understand where Powell is coming from by trying to look at services net up, net up shelter. But, of course, that metric, though, is very, very steady. And it has been very, very steady historically. It's a little bit elevated beyond where it was. But in terms of it ever turning negative, you'd have to only go to the one time stamp of the great financial crisis. That's it. No other one exists. So, in other words, you'd really have to, as my old mentor Harvey Rosenblum used to say, you'd have to really have the peanut butter hit the fan to see core net of shelter really, really flash any kind of red deflationary signal.

28:19Um, but, but I think that, I think that the one thing that the committee does have to be attentive to, we've had 1.2 million apartment units come online in the last three years. We have another million units coming online between now and the end of 2025. We're building single family homes and apartments multifamily at the fastest pace since the 1970s, but our, our, our population's not growing as it did when the baby boomers were all coming of age. So I think we have to be attentive in the coming 12, 18 months that all of a sudden there's not too much of a focus on shelter prices coming down too rapidly.

28:56And that pendulum swinging too far, as is often the case with mean reversion. You get a little bit of an over movement on one side and it swings back too far on the other as well. So inflation is going to be a very fluid subject, I think, going forward. So it's going to keep us all on our toes. We need that. I'd like to shift gears and move the discussion towards whether 2 % is within reach for the Fed Reserve, say, over the next two, three years here. Danielle, I'd like to start with you. If you look at forward-looking indicators right now, also considering the stickiness of this shelter component of the inflation basket, is it even feasible to return inflation to the 2 % target over, say, one, two years from now?

29:40Well, I think it is because the United States economy does not exist in a vacuum. So to suggest that the third largest exporting nation in the world, Germany, is in recession, they've just had some revisions that have given them a third consecutive quarter of contraction. We see what's happening in China. China is exporting deflation. I don't think that we can discount that effect. Can we quantify it? Well, heavens no. But I don't think by the same regard that we can dismiss what's happening in China and the fact that it looks as if the Chinese government right now has the sufficient stimulus to help their domestic economy, but not the world at large, as was the case with the most recently the 2015-2016 industrial recession.

30:23So we're not going to have some large commodity super cycle breakout right now because of what's happening in China. And that's why we're seeing West Texas Intermediate below$80 today and two weeks in a row. Global demand is what I'm saying is going to play into what happens. 40 % of U.S. S &P 500 components, they get their revenues overseas. So we have to be mindful that every time the economics community, mostly on the sell side, says, oh, it's a great decoupling. Well, we've heard this before. And decouplings tend to last for about as long as the narrative lasts. And then it goes away again because we are a globally connected, interdependent economy.

31:09Mr. Lockhart, I'd like to pick your brain on how important the global cycle is for the projections within the Federal Reserve. If China is in a recession, if Germany is in a recession, how important is it to the forecasts of the committee, given your experience from the committee? Important, noteworthy, but not decisive. The United States economy, relatively speaking, is insulated from some of the global pressures, at least more than a lot of other economies. Germany was mentioned by Danielle. Many of the more export-oriented economies, simply the heart of those economies beat at the pulse of the global economy.