Powell Says Fed Will Not Allow Large Overshoot on Inflation

Federal Reserve Chairman Jay Powell answered a letter from Senator Rick Scott (R-FL) outlining concerns about a potentially significant rise in inflation. His response gave some more contours to the Fed’s intentions around it’s mysterious Adjustable Inflation Target (AIT) framework. The Fed chairman usually avoids tying himself into any obligatory statements and tends to shy away from hard numbers but did seem to indicate some of the more extreme speculations about what the Fed could do around inflation in the media are hyperbolic. Powell by and large stuck closely to the script he has recited so well for months. However, he elaborated that he didn’t see a future where inflation substantially exceeds 2% for a prolonged period. He underscored that regardless of the new framework the Fed will always pursue its dual mandate.

Whoever leaked the Biden capital gains plan this week may have done Jay Powell a favor by proxy. Going into the upcoming Fed meeting, 1-year inflation expectations rose to 3.7%, which was the highest level in 9 years. This was up pretty significantly from 3.1% the prior month. Even the whiff of tax increases should help to assuage raising inflation expectations and make a ‘squeeze’ less likely. The real takeaway is that Powell moderated the comments of some of the ultra-dovish Fed members that have been raising the specter of allowing 3% inflation. This is accompanied by a flurry of other bullish activity across the economy.

In the past week, high yield credit (U.S. junk bonds) dipped below 4.00% and April is on track to potentially be the busiest month since records were being kept for the high-yield market. This stands in stark contrast to the behavior of some of the Epicenter stocks in the past month. The two appear to have decoupled somewhat.

Despite recent historic levels of spending the low rates have actually brought collective interest payments on the national debt down to $345 billion which is approximately 1.6% of GDP. At current rates of spending, it is on track to go down toward 1% over the next 3 years to its lowest level since the 1960s. CBO projects that interest as a % of GDP will rise significantly from 2025-2031 though, more than doubling from an estimated 1.1% to an estimated 2.5% in a decade.

The Fed’s Vice Chair for Supervision, Richard Clarida seemed to confirm Powell’s diplomatic tone in a speech on April 14th. Clarida similarly tried to assuage some of the more radical interpretations of the Fed’s new framework. He stressed that the Fed’s actions will be tied to a goals and outcomes based approach. Actual progress will dictate what subsequent action is taken.

“I think our new flexible average inflation-targeting framework as a combination of temporary price level targeting at the effective lower bound, to which temporary price level targeting reverts once the conditions to commence policy normalization articulated in our most recent FOMC statement have been met. In this sense, our framework indeed represents an evolution, not a revolution, from the flexible inflation targeting framework in place since 2012”- Vice Chair Richard Clarida

The elaboration by both Powell and Clarida on the framework likely is aimed at criticism that the Federal Reserve has been too opaque with markets about its’ intended course with regards to inflation and just how exactly this framework will interact with the dual mandate.

Asset purchases continued at a pace of $40 billion a month for MBS and $80 billion a month for Treasuries. The benchmark yield on the 10 year is 1.56%.

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