Fed Watch: Policymakers Grow Defensive As Recession Worries Increase

Some of Federal Reserve Chairman Jerome Powell’s remarks at his press conference last week make you wonder if he’s living in a parallel universe.

Talking about the tight labor market, Powell praised the strength of the economy.

“It's a strong economy and nothing about it suggests that it's close to or vulnerable to a recession."

Except maybe the 1.4 % decline in US GDP in the first quarter. A second such decline in the second quarter would mean a recession this year already, although inflation is clearly far from being tamed.

A lot of smart people think a recession is inevitable, but when Powell was challenged on that score by a questioner at the press conference, he stuck to his position.

“I think we have a good chance to restore price stability without a recession, without, you know, a severe downturn without materially high, higher unemployment.”

Powell is still hoping for what he called a “softish” landing for the economy, where activity slows down but avoids an extended downturn.

For a brief moment on Wednesday, Powell seemed determined to go down in history as the Fed chairman who brought back the punchbowl. He declared with certainty that any interest rate hike higher than a half-point was not on the table, dismissing a question about a 75-basis-point hike as something policymakers are not “actively considering.”

The Fed chairman said further half-point increases are probably in store, but went on to suggest that the Federal Open Market Committee might be able to go back to the smaller quarter-point hikes if incoming data allows.

Not A Question Of If, But Rather How Bad

Markets initially took his remarks to mean that happy days are here again and investors loved it. Stocks rose, Treasury yields dropped. Until they thought about it more, and put markets into reverse, sending stocks plunging and Treasury yields jumping the very next day.

Commentators started ticking off former Fed officials who thought Powell was being too optimistic about rate increases. The FOMC will have to push them higher than policymakers think to catch up with inflation, making a recession all but inevitable.

Former vice chairmen Richard Clarida and Randal Quarles said as much, while former New York Fed president Bill Dudley, and even mild-mannered former governor Alan Blinder, see a recession as likely.

Fed critics, like economist Charles Calomiris, think it is no longer a question of whether there will be a recession, but how bad the downturn will be. As he pointed out last week:

“The Fed missed its chance to tighten without a recession. The longer they delay and pretend they might still have that chance, the more severe they’re going to make it.”

Part of the problem is that Powell and his Fed colleagues are in an awkward position. The chairman delayed action on interest rates because he was waiting to be re-nominated.

Now, for all his tough talk, he is moving fairly slowly to tighten monetary policy because his political antennas tell him that high interest rates and recession are not a good look for midterm elections.

A CNBC poll of small business owners found last week that 8 out of 10 surveyed expect a recession this year, showing themselves more pessimistic than Wall Street professionals who breathed that brief sigh of relief on Wednesday with the market rally.

As the criticism mounts, Fed policymakers have grown defensive. Christopher Waller, a member of the board of governors, said last week that the FOMC was not the only group of forecasters that got inflation wrong last year.

But it’s the only group that matters, and they really can’t afford to get it wrong without everyone suffering the consequences.

By way of an excuse, Waller, a former chief economist at the St. Louis Fed, noted that the FOMC brings together a diverse group of policymakers, each with their own opinions about how best to achieve the Fed’s dual mandate of maximum employment and stable prices.

“We need to reconcile those views and reach a consensus that we believe will move the economy toward our mandate. This process may lead to more gradual changes in policy as members have to compromise in order to reach a consensus.”

This sounds a bit lame, but it was no doubt easier to influence policy when Waller had an audience of one. His former boss, St. Louis Fed chief James Bullard, has been in the forefront of those arguing for more aggressive action by the Fed.

Economist Robert Brusca said last week that the Fed has missed the boat and a recession is now unavoidable.

“Oh, we see recessions coming ahead of time but not with enough warning to act. Sort of like the Titanic seeing the iceberg but…too late. The Fed has models, lots of ideas, a boat load of economists, but probably no longer the right options.”