Fed Impatience and the Ghost of Volcker

02.07.2023 In his quest for credibility, Federal Reserve Chairman Jerome Powell has been beating a hawkish drum. Today’s Q&A session, Powell’s first public appearance since last Friday’s blowout jobs report, is just the latest hawkish example of the Fed’s Open Mouth Policy.

The jobs report prompted a cavalcade of arm-flapping monetary policymakers to argue that overnight rates need to go higher and stay there for longer to address today’s inflation environment.

The Fed’s “get tough” sound bites are meant to hem in investor expectations. The Fed governors have been frustrated with investor expectations of rate cuts later this year. Fed Fund futures trading continues to forecast lower short-term rates in H2/23.

The disconnect between the markets and the Fed has to do with the lag between policy, in this case overnight rates, and economic results, in this case inflation. History shows the time between a peak in the Fed Funds rate and the subsequent inflation trough can range anywhere from 17 months to over three years. If history is correct, a May or June rate peak would correspond to an inflation bottom somewhere between November 2024 and August 2026.

A Federal Open Market Committee that expects to crush inflation this year would not only be disappointed, but they would likely raise rates too much and hold them there too long – resulting in unnecessary damage to economic growth, profits and jobs. If Jay Powell is a Volcker acolyte, then he needs to pay attention to history, lest he repeat it.