The Fed's Biggest BEAR *JUST* Flipped

well we always like to align you know

with where the markets are or not we

don't want to surprise the market so the

alignment I think is is closer than it

was before but you know we're going to

set policy to do what we have to do to

get back to price stability so we've

been raising interest rates we've seen

some of that working through the economy

we have seen some pressure off the

inflation but inflation remains too high

and as as you know coming out of the the

meeting last time in the minutes showed

earlier this week that we're going to

have to do a little more to get that

back to price stability of two percent

so I said yesterday there's only one

species of fed official now a greater or

lesser Hawk where do you put yourself in

that if at all um are you sorry about

the audio glitch it's fixed average or

medium uh fed funds uh forecast for

among that officials of five and an

eighth or are you higher or lower than

that so as I always said to you I'd like

to be known as an owl not a hawk or a

dove but for for his wisdom right

exactly but it's not up to me to call

myself that

um you know I

see a little more impetus in the

inflation measures than my colleagues

did at least in December when we put out

the last SCP readings the summary of

economic projections so I had my funds

rate a little bit above the median in

that projection and I haven't really

seen much change in my outlook for the

economy since since that time so I see

in that we're going to have to bring

interest rates above five percent and

we'll we'll figure out how much above

that's going to depend on how the

economy evolves over time but I do think

we need to be somewhat above five

percent and hold there for for a time in

order to get inflation on that

sustainable downward path to two percent

but it's maybe significant what you're

saying is you haven't seen anything in

the interim that causes you to change

what your dot was in December no I think

I'm where I was because remember I saw a

little bit stronger more inflation

impetus than the medium did and I also

think that

um the the labor markets I'm not really

seeing a trade-off between the hot labor

market and inflation I'm really focused

on inflation what we learned over the

last expansion the pre-pandemic

expansion is that you know the

unemployment rate can be very low

without necessarily spurring inflation

so I'm really focused on the inflation

numbers and I don't see that we have to

have this trade-off necessarily between

labor and price stability in fact I

would say I'm greedy I want to have

healthy labor markets and a return to

product my colleague Joe Kern wants to

ask a question but I want to just get

one more before before we get to him

um the real question I want to ask you

is what the heck's going on with the

economy we're supposed to be an economy

that was right now either in recession

or on the way to recession we printed a

half million jobs for January we had

retail sales go through the roof is this

all seasonal adjustment is this economy

weakening or is it ignoring the FED when

it comes to Greater rates no I don't

think it's ignoring I mean we've seen

some of the impact with higher rates

certainly if you look at the housing

market right that's definitely clearly

slowing right manufacturing slowed a bit

now we have some impetus that suggests

that maybe it's not slowing as fast as

we thought so you know if you had to

sort of characterize what's happened is

coming into this year there's probably a

little bit more underlying strength and

a lot of forecasters thought but there's

also some movement good movement on the

the inflation measures they are coming

down it's just that the level of

inflation is still too high which is why

coming out of our last fomc meeting the

broad you know consensus was among all

the participants was that we're going to

have to do more which is why you know

the statement said ongoing increases Joe

thanks Steve president master I'm just

trying to get uh some insight into the

idea of of maybe 50 basis points and why

it might have made sense why it ain't

happening theoretically it could still

make sense like I think if if you know

where you're going or a pretty sure of

it and you need to get there you might

as well get there is the argument I'm

wondering whether

uh maybe everybody else is is or some

people are more cautious is because we

it's there's still data dependency is it

possible that something happens more

quickly in terms of of a weakness in

some area so that is there a reason to

just do 25 because if you need to do 50

you might as and go higher than that you

might as well do it unless you're

leaving an opening for data to come in

that shows that you didn't really need

to go that high is that why you don't go

50.

yeah so Joe it's a good question about

tactics about where how you know to get

to where we need to get to you know I

I'm on the record saying that at the

last meeting I saw a good economic case

for doing 50. because my view of the

Outlook hadn't changed and I do believe

we're going to have to move our policy

rate above five percent at a 50 at the

last meeting would have brought the top

of our target range to five percent but

you know other people on the committee

had different views and so that's what

the value of having people sit around

the table as we come up with sort of a

consensus view now at every meeting

right we go do that same kind of

analysis we look at where the economy is

we look at the incoming data we project

out where we think the economy is going

understanding that the economy can

evolve in different ways than expected

and then we set our best policy path but

I think the message coming out of the

meeting was we've got to keep going a

little bit more we've come a long way we

brought the funds rate up quite a bit

but we still have a little more work to

do in order to sure that we get back to

price stability and making sure that

we're commit making sure we're committed

and people understand our commitment is

what's going to be able to get us back

to price stability we support a 50 at

the next meeting I don't go I don't

prejudge right I go into the meetings

and I'm going to look at the data and

we're going to have a new set of

forecasts and that's going to help guide

where we need to get to but that's a

tactical decision that we make at the

meeting right it's got to be based on

where we're going how much the economy

is slowing in terms of getting demand

back in line with Supply and of course

the supply chain issues are also

improving so there's two things going on

demand is moderating and if you talk to

our business contacts and our labor

market contacts in my district and I

would submit in a lot of the districts

right they are businesses are saying

that things are moderating so I know a

lot of people think that well the date

is lagged and you're only looking at the

past we have a lot of contacts across

the districts that we talk to all the

time and that's very important because

that's forward-looking they're telling

us what they're planning to do Andrew

has a question for you president can you

succeed at reducing inflation without

raising unemployment and on the

unemployment front what do you think a

politically palatable unemployment rate

is yeah yeah

well you know this is a interesting

labor market to say the least it's it's

shown a lot of strength there are

structural things going on in the labor

market as well as cyclical things so I

do believe that we can get demand down

um without seeing the same kind of uh

rise in unemployment that in in past

slowdowns we've seen and in fact when

you talk to businesses a lot of them

said it's been so painful over the last

couple years and they've spent so much

effort to hire people that they're going

to do everything they can even though

they're anticipating some slowdown in

demand for their output they're going to

do everything they can to keep people on

staff so they after we get Beyond this

slow down and get back you know on the

path to price stability that they'll

have the staff they need and in fact

some of our firms in our district are

still hiring because they're

anticipating that if we do have a

Slowdown it'll be mild and then we're

going to go back to a really healthy

economy so I do think that then in this

labor market we can get that we can have

both we can have healthy labor markets

and we can go back to price stability

but I also think it's really important

to know that if we want to sustain

healthy labor markets over time we've

got to get back to price dually so

that's why I'm very focused on that

aspect right we've got to get inflation

down we have to get back to our two

percent goal in a timely way and that's

why I'm focused on that right now the

problem president Mester is history is

not really on your side you don't have

you as I mean the Federal Reserve not

you personally doesn't have a terrific

track record of bringing down inflation

without a recession

and this is the other side of Andrew's

question which is do you think a

recession is likely can you avoid a

recession and still get back to your two

percent questions so my forecast is that

growth will slow this year and be well

below Trend

um I still hold to that forecast so when

you're that low you know it doesn't take

much of an some kind of shock that

you're not anticipating which is the

nature of a shock you don't anticipate

them that can push you into negative

growth for a time but you know when you

talk to your business contacts you know

they're all sort of preparing for that

kind of recession but when you talk to

to a one they say it's going to be mild

so again I I think we can get back to

price stability what's different now Is

our commitment to getting back to two

percent and all the things we've learned

over time about how important it is to

have that commitment to communicate it

to be very clear about where we're going

right as clear as we can without being

present we're not present right but to

be very clear and that's what's going to

get us back to two percent there was a

very important concept embedded in Joe's

question to you which is one about lags

we just had Jim Bullard on from St Louis

he said this is 2023 there are no lags

anymore I'm overstating what he's saying

do you think there are lags that are yet

to hit this economy that will I guess

offset the need for you to go quite so

high so there are two things one is we

have been very much different this time

in terms of communicating where we're

going so what you saw right when well

before we made that first rate increase

back last year at the beginning of last

year right markets had already priced in

some of that because we were

communicating in advance that doesn't

detract from the fact that it does take

time for those rate increases to go

through the economy so the financial

markets reacted but it still takes time

to get through and we saw that in the

housing market it didn't react

immediately it took even in the housing

market which is very interest rate

sensitive it took some time those lags

are still there so I do believe that you

know we're going to start seeing you

know more of what we've done in the past

affect the economy but nonetheless if

you just look at at what's going on in

the economy now the strength the fact

that inflation Still Remains High the

fact that you know parts of inflation

are coming down but other parts

including the important service sector X

shelter have not moved we're going to

have to do some more but we are making

progress on that path Joe uh president

Master if if Energy prices

um if something happens there I don't

know we're using the spr you know take

your pick on on what could cause a spike

there if and I know you could do core

maybe to try to factor that out but then

it seems like it filters through to

everything else

if if that's why inflation stays

stubbornly high would you continue to

work on slowing the overall economy when

really you're not it's not really why do

we have the inflation you can't really

address the the energy supply problem

so it just seems like that would be a

bad reason to go much higher than you

need to go in terms of tightening for

something you can't really control

yeah

so Joe it really depends on what's

causing that and you know the energy

prices arise if it's because demand is

still well outpacing Supply then we're

going to have to think about what that

means in terms of the path of inflation

if it's a supply shock which is typical

what you what you're I think what you're

talking alluding to then right you're

exactly right we have to look at what's

the underlying inflation rate what are

inflation expectations doing which are

all important anchoring them keeping

them at two percent over the long run so

long run inflation expectations are

still reasonably well anchored and so

we'll have to do that judgment but

you're exactly right this is a risk

management kind of a process that we

have to go through so it really depends

on the source of that rise in interest

rate we're going to have to go real

quickly but we've been giving every

beneficial we're talking to a hard time

about the following you guys had it

wrong when it came to the inflation and

policy inflation surged up and the Fed

was on the wrong side of that trade why

should we have confidence now you have

this right this time well you know we're

just like every other Economist trying

to do the best forecasting job we can I

think we reacted well in terms of once

we agreed that this inflation impetus

was there it wasn't going to dissipate

quickly that we were really going to

take action we did that and we are very

committed to getting back to price

stability in a timely way all right

president Mr thanks for joining us and

okay listen to this look I I just I'll

talk about what she just said in a

moment but this was scary okay you ready

for this look at this I've hey quick

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the weekend never seen this before so

obviously the FED officials they

regularly bring up inflation

expectations and I've never seen this

before this just this is the first time

I've actually seen this on this

particular chart and it's not just this

chart it's also when I zoom out even

more but let me explain this to you

because it's kind of scary and then

we'll talk about what Master just said

but it and it's scary because of how

uncertain or how much uncertainty it

creates all right so what I want you to

think of first is this blue line right

here or inflation expectations this

white line are Financial conditions so

the higher the white line goes the

tighter things are think about it as

like 10-year treasure yields interest

rates are more expensive the market is

crappier right so things things are

tougher for businesses and expansion

when the white line is up and when the

blue line is down it suggests

disinflation or deflation even right so

generally what you see is as Financial

conditions tighten the Market's

expectations of inflation go down it was

true over here in 18 it was true in the

pandemic it's pretty much always true in

fact let me show you pretty much always

true by zooming all the way out to when

this financial uh this this sort of

tightness chart started or the break

evens chart started over here in the.com

bubble

you can kind of see the inflation

expectations go up over here on the left

when we see Financial conditions come

down in Great Recession you see

Financial conditions up and you see

break evens down okay all right so we

got that now what is happening that I

haven't seen before and this is a little

odd because it's it's sort of breaking

the tradition of what we usually see and

we know it's something the Federal

Reserve really pays attention to okay

ready for this look at this chart

now look on the far right side

look at this this is so weird

Financial conditions are tightening at

the same time

as break evens are moving up

that's bizarre usually break evens come

down as Financial conditions loosen in

fact you can kind of see this loosening

over here and we loosen expectations

over here we uh had this this uh um uh

but but I can't say we have much of a

correlation between some of these so

there's a lot of I guess maybe the way

to look at this because as I'm looking

at this a little bit more the way to

look at this is it's super odd and

volatile right now relative to what

we've seen in the past right generally

again in the longer term as these

conditions fall break evens uh arise as

the conditions rise break evens fall but

right now we're having this sort of

bizarre moment where yields are going up

expectations for the market are

tightening or getting higher but

inflation expectations are actually also

Rising so it's kind of bizarre because

it somewhat the only implication I could

pull out of this is that the market is

suggesting we need even tighter 5

Financial conditions to actually keep

this downtrend moving on the breakevens

now that somewhat aligns with what

Loretta Master says which look we've got

to get above 5.1 percent and what did

she really tell us well one of the big

things that she reiterated was something

that we've heard about in the fomc

minutes which is that look the housing

market is slowing down and Manufacturing

is slowing down slightly but not as much

as we'd like

notice that kind of combination there

manufacturing is slowing but not as much

as we'd like or expect housing is

slowing and then kind of like yay that's

what they want right they're trying to

engineer a housing slowdown because the

housing slowdown is exactly what reduces

demand and spending and that brings

inflation down she also is one of the

first folks here she was supposed to be

the basically the Big Bear who's going

oh 50 basis points 50 basis points today

she's like ah you know I said 50 last

time but I don't necessarily have to say

50 this time I just wanted to say 50 so

we get closer to the high end rate of

five percent well I mean if they do 25

basis points in the next meeting they'll

have the high end rate because remember

it's a range when they raise rates they

give us a range so if we're at 4.5 to

4.75 now well if we raise another 25 BP

what do we get 4.75 and 5. right so you

can achieve what she wanted to achieve

last time this time with the 25 BB hike

that just reiterates what I'm saying

over the last few days and quite frankly

for a while that I think it would be

ridiculous for the Federal Reserve to go

50 now even though that's probably what

they should do they'd be shooting

themselves in the foot in terms of

credibility for what they have left

anyway but let's put some of that aside

what else uh did she mention that was

quite odd or maybe should I say

different for fed folks well she talked

about basically without using the words

the Phillips curve being broken now

that's really interesting because

generally in order to bring inflation

down you have to force unemployment

especially if there's a wage price

spiral wage price spiral you have to

kill the economy Force employment bring

things back to normal 1980s all over

again Paul volcker right okay fine so

since then uh and even prior to that

traditional Keynesian thought uh and Via

even the the Phillips curve which you

know was created in the 90s well after

uh John Maynard Keynes and his economic

theory series but anyway this Phillips

curve was was this idea that hey look in

history we always have to force

Unemployment uh to to bring inflation

down and she made the argument here that

no we don't think so we think there are

things happening in the labor force that

make quote unquote this time different

because people aren't laying people off

because they went through years of

struggling to find people so maybe if

everybody's just sort of patient and

walks through whatever this is whether

it's below Trend economic growth or a

shallow recession maybe as long as we

can get through the pain of of you know

last year and this year and we suffer

with our flat earnings or our negative

EPS for a year or two and and then we we

basically as American Express says spend

through the recession and use the

savings we built up to sort of survive

and get to the other side as businesses

and individuals well there may be things

just won't actually be that bad and we

don't actually have to force

unemployment up

for inflation to come down that's the

argument she just made I mean if you go

back and just rewind and listen to it

she was pretty clear that we don't need

to break unemployment the unemployment

rate can be very low without spurring

unemployment that stands in complete

contrast to what the Federal Reserve

basically has been teaching for for

decades which is this idea that the

Phillips curve says if inflation is low

uh the unemployment rate or to get the

inflate to get inflation down the

unemployment rate must go up because

then in other words what labor earners

have less pricing power and if labor

earners have less pricing power they

bring inflation down because this you

basically have the opposite of a wage

price spiral right labor gets cheaper as

it competes for dollars and that enables

prices to come down uh as company

margins can rise in excess maybe of even

their their labor cost savings uh and so

so their need to raise prices evaporates

and then pricing uh uh comes down Top

Line pricing comes down so that's where

sometimes pricing power gets a little

bit tricky because we generally think of

pricing power is oh they can raise

prices well look Tyson Foods might be

able to raise prices but if their margin

you know if they raise prices 10 and

their margins are are compressing 20

well they're losing more money right

even with higher prices so really like

ideally for for a company uh you can

actually reduce prices and your costs go

down even more because now you could be

more competitive against your

competitors uh you could be more

competitive some more of your product

and boom you win right like you you end

up making more money at lower prices

that's the ideal scenario so I think

it's interesting my sort of my big

takeaways uh from what Loretta Master

said were a inflation expectations are

still anchored which I agree with her

but they're starting to do something

weird it might just be short-term

volatility and that the market is now

expecting that we have to tighten

Financial conditions even more but sure

I suppose if you look out and zoom out

more sure they look anchored but I I you

know I I don't like this recent rise

we've had in inflation expectations I

think they're going to to pay attention

to that and if we have to bring

Financial conditions back up to these

levels well that's going to be in

10-year treasury yield at four and a

half percent and real estate gets hurt

even more right uh her taking this

strong stance that the Phillips curve is

broken we don't actually have to force

unemployment because people are hoarding

employees also quite interesting and her

reiteration once again that the housing

market essentially has to keep coming

down which is what we've heard your own

policy at the beginning of last year the

middle of last year and reiterate in the

minutes really to me suggests the FED

wants 10-year treasuries up they want

real estate down that's the goal of the

fed and they don't really care what

happens in the stock market in the short

term we'll see but that seems to be what

uh what Loretta Master suggests and it's

also interesting that she basically just

walked back this idea that she's 50 50.

she made it clear hey like I was 50 to

get the upper end to five percent well

guess what in the next meeting you can

get the upper end to five percent with a

25 BPI right after all 25 25 is 50. so I

have to say if she's a hawk and she's

listening to her contacts as leading

indicators if she's considered a hawk

this was bullish and I'm not I don't

think I'm trying to be like you know put

the bias on or whatever and I want it to

be bullish like if this is hockey I tell

you you know uh you know

this if she's a hawk that was bullish

you know whether that's the leading

indicators they're seeing or the leading

contact stuff they're at whatever right

you know they're teal books and their

economic reports from their industry

contacts

whatever you say that was not a bearish

fed talk and she was supposed to be one

of the Bears that was driving the stock

market down over the last few weeks here

over this fear