Fed Vice Chair Jefferson Emphasizes Hawkish Caution and a Nimble Approach to Policy
The title of VC Jefferson’s speech, “Is This Time Different? Recent Monetary Policy Cycles in Retrospect” suggests that the past may be prologue for the current cycle.
The key near-term policy line from the speech was, “we always need to keep in mind the danger of easing too much in response to improvements in the inflation picture… Excessive easing can lead to a stalling or reversal in progress in restoring price stability.” During a follow-on Q&A period he noted that rather than any specific indicator or threshold for initiating cuts, the cutting cycle would begin when “body of evidence” pointed in that direction.
He notes two key conclusions when looking at the historical record. First, “the easing cycle that started in July 1995… started predominantly because of reduced inflation concerns. All the other easing cycles started because either there was a concern about slowing economic growth, or, in one case, because there was a concern about slowing economic growth and there were reduced inflation concerns.” Second, “history is replete with events that complicate monetary policy decisions [and accelerate slowdowns into larger shocks or recessions].” The key lesson of these shocks is that “policymakers need to remain vigilant and nimble… and that policymakers need some good luck.” As much or more than the current economic base case or risk that the cycle ends of its own accord, this type of Krightian uncertainty is what drives the downside rates and risk tails.
(Here for my own deep dive on Fed mid-cycle corrections from December. I lean fairly heavily on the 1994-96 hiking cycle example in the current moment given the rapidity of the tightening cycle and inflation concerns which drove it.)
If there is a revealed view here in Jefferson’s framing that it might take growth weakness to lead to the initiation of cuts, rates repricing and the feedback loops between LT rates and durables/housing demand mean that it may take some notably more hawkish price action to see cuts realized. I don’t think that is the broader view of the FOMC or Jefferson’s base case, especially in light of the numerous mentions of the 1995-96 cutting cycle as the “perfect soft landing,” a line Jefferson borrowed from former Fed Vice Chair Alan Blinder (here), but it serves as an example of an optimistic-hawkish path we could end up taking.
My underlying view remains that the inflation data continuing to be ‘good enough’ is what will allow the Fed to begin cutting but the depth of the cuts will be driven by the labor market and growth data, where the recent data flow seems to be continuing to lean against the Fed’s articulated view that policy is clearly restrictive.
The Fed’s base case remains that (or at least I’ll assume Jefferson as Vice Chair is speaking in a way that is very close to consensus if not exactly ‘for the Committee’ in a formal sense), “if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back our policy restraint later this year.” The risk though, as I’ve mentioned several times recently, is that the Fed’s baseline outlook is premised on the view that the policy rate is “well into restrictive territory, and our restrictive stance of monetary policy is putting downward pressure on economic activity and inflation.” The question here is how dependent on the stance of policy the inflation outlook likely to be, perhaps very little in the near-term, and how spot data versus inflation forecast dependent the Fed is likely to be we get closer to beginning to cut.
Jefferson mentioned 3 main risks to the outlook, with two leaning somewhat inflation hawkish relative to current expectations (“consumer spending could be even more resilient than I currently expect it to be, which could cause progress on inflation to stall” and “geopolitical risks could remain elevated, and a widening of the conflict in the Middle East could have greater effects on commodity prices, such as oil, and on global financial markets”), while the other implies dovish risk management concerns, noting that “employment could weaken as the factors supporting economic growth fade.”
