Recapping Powell's Jackson Hole 2021 speech

On the inflation front, the Fed is holding the line on their view that inflation is transitory with much of the inflation observed to date occurring in durable goods. The Fed cites two examples: the spike in lumber prices from earlier this year that has rolled over and used car prices currently stabilizing. However, as the COVID-19 delta variant continues to spread across the world, supply chain disruption remains a factor which may sustain the current inflation trend in some segments of the economy. Personal consumption expenditures, the Fed’s preferred inflation metric, has shown a sharp uptick into 2021. (The PCE index is known for capturing inflation across a wider range of households and consumer expenses than CPI.)

In labor markets, Powell sees room for further improvement, specifically citing that the total U.S. employment is still six million workers below February 2020. He has indicated that he is currently more focused on the labor market vs. current inflation readings due to the transitory view on inflation and ongoing labor market slack.

One major point of emphasis in the tightening discussion is a gap in timing expectations between tapering and rate increases. The Fed chair made it clear that after tapering they would be patient and data-dependent on increasing rates, which caused the shorter-term treasury yields to decrease as the market’s rate hike expectations moved further out. Federal funds futures are currently pricing in a 56% probability of at least one rate hike by December 2022, down from a peak of 74% this June.

Looking forward, there are many major changes on the horizon that will flow through to the economy and markets. Pandemic unemployment assistance is scheduled to expire on September 6 and the Supreme Court recently blocked the CDC’s eviction moratorium on August 26. On the fiscal front, proposed stimulus bills face an uncertain future with a September 27 House vote deadline for the $1 trillion bipartisan infrastructure bill and the $3.5 trillion budget proposal still caught up in negotiations between progressives and centrist Democrats. Supply chain disruptions are ongoing which will likely continue to flow through to inflation data.

Real estate markets have also seen major impacts from the pandemic and Federal Reserve policy response. Temporary interruption of new supply, record low mortgage rates, and a boost in demand for homes have led to a 16.6% YoY increase in home prices in May 2021. Movement to lower-cost regions in the era of remote work has also had major impact on certain markets. Supply chains and labor market conditions will continue to influence the time required and cost to build new construction. Rents have also increased, with the national median rent increasing by 11.4% so far in 2021. Housing costs account for ~24% of the personal consumption expenditures index, so this may be a key indicator for the future path of interest rates.

In summary, the two biggest drivers for the timing and magnitude of policy tightening are labor market improvements and sustained, non-transitory inflation. While Powell is continuing with the view that current inflationary pressures are transitory, continued inflation in stickier prices such as housing and rent costs or in consumer goods prices could test this view. It would be wise to keep this possibility in mind and consider the potential market impact if Powell is incorrect on transitory inflation, re-pricing an increased pace of tapering or future rate increases, with key catalysts coming from employment and inflation data.