Face-to-Face with the Fed

April 12, 2018

The new head of the Federal Reserve, Jerome Powell, recently made his first public speech as Fed chair, which happened to be in Chicago. We were part of hearing that message directly. One warning: if you ever watch a Fed chair talk, don’t expect a riveting presentation. The statements are carefully prepared and delivered in a monotone fashion so as not to allow for unnecessary market interpretation about anything. Despite that, the content had some interesting items worth sharing.

The Fed’s mandate is two-fold: maximum employment and stable prices. Mr. Powell spent little time talking about inflation as it’s pretty much a non-issue right now. In fact, it has mostly been this way the last 12 years.  Inflation (core) is at just 1.6% and expected by Mr. Powell to move up to 1.9% this year and 2% next year, stabilizing in that range. The Fed targets 2%, so right on target.

Mr. Powell spent a larger amount of his time talking about maximum employment. Unlike inflation, there is no explicit target for maximum employment. Mr. Powell noted this is because it is not directly measurable and can change over time.  Some have historically referred to a level around 5%. Currently our unemployment rate stands at 4.1%, which may feel tight. Mr. Powell agreed that it is indeed a tightening labor market, but there is room to go lower without impacting inflation much. In fact, he projects levels to drop well below 4% and stay there for a sustained period, something which hasn’t happened since the 1960’s.

Why?  He posed a couple of reasons:

  • Unemployment isn’t a perfect measure. It doesn’t count people such as those working part-time who really want full-time or those that haven’t actively looked for a job in the very recent past. Other metrics the Fed looks at are broader, like U6. U6 counts those whom the traditional unemployment rate ignores. Today, U6 measures around 8%. This is lower than pre-recession levels, but not as low as the late 90’s/early 2000’s.
  • Labor Force Participation remains low – The percentage of the working age population in the labor force has been about flat the last 4 years, leaving room to grow.
  • Wage growth is moderate. Even with a recent uptick, wages aren’t increasing quickly. This means less pressure than normal on inflation from such a low headline unemployment rate.

Looking ahead, Mr. Powell noted:

  • More of the same policy: Everything discussed supported the idea of a continued, gradual tightening of monetary policy, which the Fed has been doing since December of 2015.
  • Slow growth (but still growth!): While growth expectations are a little higher this year, that has not been the case looking back in our economic recovery or looking ahead. In fact, since the Great Recession, our economy has gained just 2% per year in growth. Compared with the previous recovery, growth is about 1% lower per year. However, even though we’ve been growing slower, the unemployment rate has declined faster. In fact, this economic recovery saw jobless rates improve about 0.5% per year quicker than the last recovery, indicating our economy might need less growth than before to achieve maximum employment.

What does this mean for you?  Look for two things: 1) But for an unanticipated external event, continued solid economic footing, and 2) Interest rates to rise, but probably gradually, and maybe not to a level as high as they used to. This is good, because as you have seen so far with bonds, this year has been a negative one. However, patience and discipline will eventually be rewarded here through a return to positive territory and a market that pays more going forward in interest than it has in the recent past.