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Powell Gets It Right


By:  James C. Denton, CFP®, Managing Partner

August 26, 2022


It’s likely few if any of you actually heard Jay Powell’s (Chairman of the Federal Reserve) speech Friday morning from the Federal Reserve’s Symposium at Jackson Hole.  If you want an idea of what to expect from inflation, the economy and probably the stock market over the next six months to perhaps a year though, you might find the 10 minutes necessary to listen to his comments to be worthwhile.



So, what did I hear?  And what does it mean?

I probably have about a half-dozen faithful followers who will read this through to its conclusion.  For the rest of you, I’m going to put my conclusions up front as an executive summary, and then I’ll follow up with the reasoning behind those conclusions, my diagnosis if you will. 

Prognosis:  1, Pain.  Not for everyone, and probably not for a whole lot of my readers, but for the overall economy, it’s going to get worse before it gets better.  2, Recession.  Not a terribly difficult one, but I very much doubt we will have that “soft landing” everyone is hoping for.  And 3, Slow Growth; a more drawn-out rather than a rapid “V-shaped” recovery.  I am not ready to call the recent roughly 15% recovery a bear-market rally or a sucker rally, but neither do I expect it to have any significant momentum in the immediate future.  My best guess right now is for six to 12 months of continued volatility and, at best, slow growth in the stock market as investors come to terms with the inevitability and ultimately, probably next year some time, the reality of a recession as an unavoidable byproduct of what the Federal Reserve has to do to get inflation under control.  

Prescription:  Stick to our discipline.  Stick to our plan.  Remember your portfolio is built to deal with the unavoidable bad days and to take advantage of the more frequent and more meaningful good ones over the longer term.  The market has its’ share of the former but more of the latter, and, given time, has always ultimately and inexorably gone up.  There is no reason to believe this time will be any different.  If you have a five-year time horizon, all of this aggravation is meaningless.  If you have a capital need (i.e., something more than your scheduled income distributions) in less than five years then we should be discussing strategy for that specific need.  But there is nothing in this discussion that calls for any radical change in direction in your overall investment plan.

Now, if you are interested enough to stick it out, here’s the academic and analytical diagnosis behind this somewhat suboptimal prognosis and Rx.

First, a very brief description of the Federal Reserve Board’s primary mandate.  It would be an oversimplification to suggest that the Fed’s only responsibility is to “control Inflation and promote full employment”, but only a minor one.  The Fed has certain administrative responsibilities throughout our national fiscal and financial systems, among them bank supervision and others of similar importance.  But their unequivocal mandate, the thing on which they are responsible to report on to congress (both houses) on a regular basis, is a dual responsibility to keep inflation under control, and to keep Americans on the job.  Unfortunately, these are often conflicting goals.

This has not been an altogether challenging task for the past 10 to maybe as long as 25 years or so.  There have been some bumps along the way but the trend for Inflation has been tame, and the employment situation has progressively improved to where we are at an all-time high of people actually on the job.  As you might have noticed though, while unemployment continues to improve, the inflation curve has reversed radically in a very short time frame.  In economic theory this disconnect should have manifested itself a long time ago (see the “Phillips Curve”), but in practice has only recently become a problem for the inflation side of the discussion.  And it now presents a serious dichotomy for the Fed.

The Fed is used to dealing with policy and practice conflict.  The Fed’s activities in pursuit of their responsibilities is referred to as “Monetary Policy”.  Their goal is to manage economic policy by managing the money supply, by increasing or decreasing the amount of dollars and “dollar equivalents” in circulation through their policy activities.  A little more on their tools later.

Congress also has economic management responsibilities referred to as “Fiscal Policy”.  Ideally, they pursue societal and economic goals through financial programs.  Tax policy, welfare, health care, retirement programs, etc., are all ways in which the congress pursues goals ostensibly in the interests of the US citizenry.  But basically the entire budgetary process, whether “entitlements” or discretionary spending, is all part and parcel of congressional fiscal policy.  (How well they do it, and all the cynical discussion is for another day, for now we’re just talking about their responsibilities and tools.)

Quite often, the Fed’s and the Congress’s activities are at cross purposes with one another.  This is especially true presently.  The former is pursuing a restrictive policy (“contractionary”) while the latter is spending like a $1T lottery winner (“expansionary”).  Fighting inflation is always a fundamental problem for the Fed considering its full employment mandate.  But this is further aggravated by the congress and its undeniably expansionary policies it has been and continues to pursue.

First we had the multiple Covid relief programs.  No fault finding here, we were in a tough spot requiring unconventional thinking and follow-through, and the stimulus payments went a long way in seeing the economy through a tough phase.  People WERE out of work, a classic need for radical action. 

But downstream is where the problem always arises.  All that money is floating in the economy now.  Those of you who have studied Economics will recognize the concept of the “multiplier effect”; essentially, every dollar introduced into the economy changes hands multiple times, increasing the means of each holder as the recipients, whether the funds are earned or gifts or stolen, spend those monies.  The multiplier can be anywhere from 5X to as much as 10X of the original infusion, depending on the source, the initial recipient (some just save the money, so no multiplication at all) and the economist and his assumptions.  Regardless of the assumptions, the result is several trillion dollars of new money floating in our money supply.  Result … ultimately inflationary pressures (the classic definition of inflation:  too much money chasing too few goods), which the Fed must factor into their models, and which increases the pain they must be willing to inflict if they are going to be effective in getting inflation under control.

But the Covid relief wasn’t the end of it.  Last year the congress passed a $1T Infrastructure and Jobs Act and those funds are just now starting to be distributed and spent.  Hugely stimulative to the economy.  This month another ~ $740B “Inflation Reduction Act” (say what?).  Another hugely stimulative fiscal action, all at the same time that the Fed is trying to design, define, implement, refine and maintain a contractionary monetary policy.  Translation … all of that liquidity congress is pumping into the economy, the Fed has to extract from the money supply, and after the multiplier effect has begun to manifest itself.  The Fed’s job is “multiplied” exponentially by the congress’ spending habits; the same congress that, first, gave them the task, and now seeks to hold them to it.

And now comes the President entering into and further “multiplying” the problem.  Normally the president’s role is limited to fiscal policy and is achieved by jawboning congress. The Fed and monetary policy are supposed to be independent, and, it’s not supposed to happen, but it is not unheard of that some of that jawboning goes in the Fed’s direction behind the scenes as well.  But the president does not normally directly control the budgeting and allocation of funds to specific purposes.  This week though, President Biden issued an executive order cancelling billions of dollars in student loan debt.  No one has put a reliable price tag on it yet, to my knowledge, and no indication of where the money is coming from, but it’s undeniable that it constitutes further stimulus to the economy – Federal dollars being added to the money supply at a time when the Federal Reserve’s undeniable mandate, and it could be argued, potentially the country’s single most important long-term economic problem, can only be achieved by reducing that same money supply. 

So hopefully you get the picture.  Chairman Powell and his herd of cats (they usually do a pretty good job of keeping their differing policy philosophies under wraps when they speak publicly, but behind the scenes, their ideas and individual solutions vary widely) are trying to achieve an already very difficult job – deconflicting inflation and full employment – while at the same time having to overcome very untimely fiscal policy decisions not just by the congress, an ongoing problem, but now with the president as well.

So, how did Powell get it right? 

The Federal Reserve has absolutely no control whatsoever over what the congress or the president do.  They can’t cajole, threaten, persuade, bargain, they have no leverage.  The congress responds to one thing … the political demands of the most radical of their constituents.  The president is equally beholden to political interests that are not at all sensitive to sound economic policy.  As you perhaps have discerned from what I have presented here, economic policy requires a long-term perspective and implementation.  Politics is all about the next election cycle.  So the Fed is not going to get any forbearance from either of their counterparts in this disconnect of interests.  Their only option is to decide just exactly how determined they are, and how far they are willing to go, how much pain they are willing to inflict, and “damn the torpedoes, full speed ahead”, if they are really determined to achieve their desired (and mandated) outcomes.

What does the Fed have in the way of tools?  Theoretically, by managing the money supply.  How do they do that?  Theoretically by influencing the interest rates the federal government pays on its debt.  How?  By either buying or selling government and other financial fixed-income securities into and out of the private markets.  Theoretically, increasing supply (selling securities) or demand (by buying securities), or exercising the same types of transactions in reverse, affects the interest rates those securities will yield, and the Fed is transacting in large enough quantities that one would expect an influence on the pricing.

You will notice the word “theoretically” reappears regularly in this discussion because this ability is, for many reasons, only theoretical, or perhaps one might even say experimental in practice. The Fed directly controls one single interest rate; the “overnight rate” that the federal reserve banks charge member banks for loans necessary to maintain overnight cash reserves in member (“National”) banks.  This is an influential power as it permeates its way through the system, but it really has little meaning in the pricing of any longer term (probably beyond 2 years, for sure beyond 5 year) government securities.  These rates are influenced far more by geopolitical factors driven as much by European and developing world central banks as they are by any policy stance the Federal reserve may take.  Another longer discussion too much for this paper.  

How did Powell get it right?  In just about every possible way.  First, he was tough.  He communicated exactly the right message in exactly the right tone.  Inflation is bad for everyone, but for the poor more than rich.  The rich may whine when they have to pay more for their luxury goods, but the poor, on fixed or worse, no income, are impacted far more basically as their essential goods are priced out of their affordability.  Therefore we have to get it under control, sooner rather than later, it’s not a task that can be handled effectively incrementally over an extended period.

Inflation has a self-fulfilling, self- fueling “personality”.  The worse it gets, the worse it’s going to get.  As economic participants, whether government legislative and executive agencies alike, corporate decision makers, or, yes, you and I as we make our individual consumption decisions, act upon our expectations of future inflation, we drive the direction and the momentum of those trends.  If we expect inflation we act in ways that cause inflation.  Bottom line – if you are the chairman of the Federal Reserve, and your job is to get it under control, then you have to do what you have to do to get it under control, because the less you do initially the harder it’s going to be and the longer it’s going to take, and the more pain it’s going to engender as the problem persists and potentially accelerates.

And that’s what I heard from the Chairman this morning.  He and his cohorts are committed to and will remain committed to fighting inflation, regardless of what the immediate cost may be.  Implicitly, the “Fed put” on the stock market has expired.  And then he shut up.  He didn’t elaborate on details, because every time he does, he creates expectations that might turn out not to be prudent, and those unfulfilled expectations become further distractions he has to deal with in the future, or more immediately, additional details for the talking heads, analysts, commentators, collectively the noisemakers who are going to make his job harder no matter what he does or doesn’t do.  He didn’t toss any new fuel on that particular fire.

So, what about the 1,000 points down on the DJIA?  I think that is a direct result of the lack of detail from the chairman.  The noisemakers didn’t have anything specific to evaluate and argue so they were left to speculate.  And speculate they did, in every possible direction.  The market is digesting and trying to figure out what it all means, and the market hates uncertainty above all else.  But that 1,000 points only means anything if you had to sell today.  Otherwise, it’s just another meaningless statistic that will fade into insignificance over the 10-to-30-year time horizon that most of us are planning for.

Hopefully some of the “influencers” will read this article and begin to give some meaningful context to their thousands of followers.  Nah.  I’m limited to my faithful few, but for those who hung in there, I hope you enjoyed my musings, and I will welcome your “oh, me’s” and your “yeah, but’s” as much as your “amens”.  I’m sure you know I had a good time writing it.


Content in this material is for informational purposes only and not intended to provide specific advice for recommendations for any individual.  All performance referenced is historical and is no guarantee future results.  All indices are unmanaged and may not be invested into directly.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.