Powell Waits for Greater Clarity While Insuring Inflation Expectations Don’t Deanchor
- Chair Powell reaffirmed that the Fed will cannot allow inflation expectations to deanchor.
- The Fed is “well positioned to wait for greater clarity” on what comes next. It has been the correct call to fade early preemptive cuts when the spot data heading into tariffs was solid, favoring mildly restrictive policy, and we are not sure what the near-term inflation and labor market impacts will be.
- Earlier in the day, the Cleveland Fed’s Hammack summarized the moment well, noting that despite the solid recent activity and inflation data, “much of this hard data is backward looking, and we as policymakers must consider the possibility that we may not be in Kansas anymore.”
- Policy over the medium-term is rerun of optimal control, but with the novel angle of concerns about upside rather than downside risks of inflation expectations deanchoring.
- One of the points which is becoming clearer across Fed speakers, and the globe, is that in the current world central banking is more about tail risk truncation (whether financial plumbing or inflation expectations deanchoring) than fine tuning in response to every variation in the hard data when the mandates are often at least partially at odds with one another.
Compared to what some have hoped for in markets, although few others in the Fed have given reason to expect, Powell seems to have refocused on the inflation side of the mandate in the near-term. “Tariffs are highly likely to generate at least a temporary rise in inflation. The inflationary effects could also be more persistent. Avoiding that outcome will depend on the size of the effects, on how long it takes for them to pass through fully to prices, and, ultimately, on keeping longer-term inflation expectations well anchored.”
As Powell has so often done since covid but is now having to do again due to tariffs, he emphasized that “without price stability, we cannot achieve the long periods of strong labor market conditions that benefit all Americans.”
In the Q&A Powell made sure to point that he does not think a looming Supreme Court case is apt to reduce the independence of the Fed’s Board of Governors. This is a clear signal that while there may be some political concerns for BoG members who would like to be appointed to be Chair (how much they let influence their policy judgements is unknown but I tend to take the under on such things mattering too much given the long history of views they all have), the overall institution will continue to try to shepherd the economy through the shocks that are now being imposed on it the same as it always would (tangentially, this raises one interesting risk that looms for 2026 is if other FOMC members see the new Chair as being overly political and the FOMC moves towards a more BoE-like median voter model, rather than a Chair-centric one). He was also emphatic in pushing back on the notion of any Fed put, beyond that based on market functioning concerns, a separate issue, or the labor market outlook contingent on the inflation one being sufficiently low.
Given the rampant uncertainty about how tariffs will affect the economy over the medium-term, “for the time being, we are well positioned to wait for greater clarity before considering any adjustments to our policy stance.” In the Q&A, Powell made explicit that at the moment the two sides of the mandate are not in tension (in the prepared remarks he repeated his recent framing that “the labor market appears to be in solid condition and broadly in balance and is not a significant source of inflationary pressure”). This would make the current mild-to-moderately restrictive stance of policy appropriate for some time, until nominal rates could follow real rates lower. That ship has obviously sailed. It has been the correct view to fade very near-term easing calls because the more mechanical inflationary impacts of tariffs will be felt fairly quickly, while the medium-term hits to the labor market and inflation are less clear in both timing and magnitude. That is true for any known and implemented policy, but particularly so when the tariff policy shocks themselves are so in flux.
Powell’s view that the Fed my find itself “in the challenging scenario in which our dual-mandate goals are in tension. If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close.” This is Yellen’s optimal control but reproposed for a world where the dual mandate is not threatened by aligned downside risks and the ZLB’s drag but a messy tension, where recession risks should be appropriately balanced against concerns of medium-term inflation’s inability to return to target-like levels. So long as inflation expectations are somewhat close to target-consistent levels, the labor market likely wins out but that is not guaranteed and likely means an attenuated downside response unless inflation is really softening quite rapidly.
Powell’s discussion of labor market did allow for the potential brittleness of the current equilibrium which has kept slack in a steady fairly healthy position. He noted that labor demand and supply growth are both falling rapidly, part of why the slowing NFP trend has been met with a fairly steady unemployment rate in recent months. He also noted that looming federal government layoffs will be a drag but it is hard to know how large and persistent it will be. The cuts to grants and research funding will also hit longer-term growth and pose short-term cyclical risks as well. Powell seems notably freer in recent weeks, trying to maintain something approximating the soft landing but also freed from ever having to get another job in DC.
Earlier in the day the Cleveland Fed’s Hammack emphasized the primacy of insuring that inflation expectations remain anchored, stating that “if elevated inflation is paired with a slowing labor market, then monetary policy will face some challenging tradeoffs. In that case, it will be important to ensure inflation expectations remain well anchored while assessing the likely magnitude and persistence of the misses to each side of our dual mandate goals.” Hammack may be a bit hawkish generally but she’s far from alone in the basic framing (as Powell showed).
As seemingly everything does these days, it emphasizes that in a world of more active fiscal policy, greater supply shocks, and less geopolitical certainty, central banks will be able to focus less intently on just the demand side of their mandate (this is Draghi at NABE 2024). Instead, ensuring financial stability and inflation expectations anchoring will be the dominant drivers of their actions. The first of these prevents excessively large output gaps from opening up due to FCI and plumbing shocks, although it cannot prevent the business cycle writ large, while the second prevents stagflation and risks of Volker-like recessions required to reanchor inflation expectations after policy shocks, across the whole of government, made low inflation uncredible (see more here). On this second point, tariffs and the ever more challenging medium-term fiscal position of the US loom large and offer some unhelpful analogs with the late-60s and 1970s or a recent history of the British economy.
