What Gives?
Does the rule that you cannot fight the Fed apply if the Fed is fighting itself?
Tuesday saw a clear demonstration that the mixed signals on the economy are dividing the Fed. In speeches given thousands of miles apart, two Trump-appointed Federal Reserve governors appeared to be sharply divided on the question of whether interest rates are likely already high enough to bring inflation back to the central bank’s two percent target.
Fed Governor Chris Waller, who for years ran the economics research program at the St. Louis Fed and was brought to President Trump’s attention by then St. Louis Fed president Jim Bullard, said in a speech in Washington that the pace of the economy appears to have slowed enough to suggest monetary policy is tight enough.
Waller’s talk Tuesday was titled “Something Appears to Be Giving,” a reference to a speech he gave in mid-October with the title “Something’s Got to Give.” In that speech, Waller argued that the recent combination of falling inflation and accelerating growth was likely to be unsustainable. “Either growth moderates, fostering conditions that support continued progress toward our 2 percent inflation objective, or growth doesn’t, possibly undermining that progress,” Waller said.
Waller’s speech Tuesday said that growth does appear to be moderating, which would allow disinflation to continue.
Federal Reserve Governor Christopher Waller at a Fed Listens event in Washington, DC, on Sept. 23, 2022. (Al Drago/Bloomberg via Getty Images)
“I am increasingly confident that policy is currently well positioned to slow the economy and get inflation back to 2 percent,” Waller said Tuesday in remarks delivered to an event at the American Enterprise Institute in Washington, DC. “I am encouraged by what we have learned in the past few weeks — something appears to be giving, and it’s the pace of the economy.”
Waller argued that data on economic activity in October indicated that spending is cooling.
“Retail sales fell 0.1 percent, the first drop since March. Spending was down on motor vehicles, an interest-sensitive sector, which may be evidence that that the FOMC’s tightening of monetary policy is having some effect. Spending was also down at gasoline stations, mostly because of a sizable decline in gas prices, often a larger factor for this segment of retail than shifts in demand. But even without motor vehicles and sales at gas stations, retail sales barely increased in October, which may reflect a broad-based moderation in demand,” Waller argued.
Although Waller did not point it out, in real terms the decline was even more marked. After adjusting for the change in consumer prices, real October spending fell 0.2 percent. Consumer demand for goods fell 0.2 percent from the month prior in nominal terms. In real terms, goods spending fell 0.6 percent, according to the Conference Board.
Waller also pointed out that the labor market appears to be cooling off and there are signs that manufacturing and non-manufacturing activity by businesses slowed in October.
Bowman Stands Ready to Hike Further if Inflation Stalls
Fed Governor Michelle Bowman, in a speech to bankers and businessmen in Utah, was far less sanguine, describing the recent economic data as “uneven.”
“My baseline economic outlook continues to expect that we will need to increase the federal funds rate further to keep policy sufficiently restrictive to bring inflation down to our 2 percent target in a timely way,” Bowman said.
In her speech, Bowman went through an extensive list of reasons to be wary that the disinflationary pressures that brought inflation down in recent months will continue to dominate. She noted that much of the progress in the past year has come from the supply side—including supply chain improvements, increases in labor force participation, and falling energy prices—but that it is unclear if they will keep putting downward pressure on prices. The inflation-dampening improvements from supply side, she implied, may run out of steam.
Federal Reserve Governor Michelle Bowman (right) and Chairman Jerome Powell at Fed Listens event in Washington, DC, on Oct. 4, 2019. (Zach Gibson/Bloomberg via Getty Images)
Bowman also pointed to the risk that higher services consumption could create sticky inflationary pressures and the lack of fiscal restraint in government spending was an ongoing danger. What’s more, households still have significant excess savings that could continue to drive consumer spending at high levels.
She seemed to be directly addressing her Fed colleagues and the Biden administration by warning against “prematurely” declaring victory over inflation.
“We should keep in mind the historical lessons and risks associated with prematurely declaring victory in the fight against inflation, including the risk that inflation may settle at a level above our 2% target without further policy tightening,” Bowman said.
The Market Sides with Waller
Financial markets liked Waller’s message much better than Bowman’s. Stocks rose for the day, and long-term Treasury yields fell. The odds of a rate cut at the Fed’s May meeting, as read by the CME FedWatch Tool, moved from around 50 percent earlier this week to near 65 percent on Tuesday.
This likely says more about the bullish mood of Wall Street than the quality of the economic assessments of Waller and Bowman.
