A review of the speech from Fed Powell by topics

Decline in Inflation So Far: (A review)

1. Origins and Initial Actions:

   • High inflation resulted from strong demand meeting pandemic-limited supply.
   • The Federal Open Market Committee raised the policy rate in March 2022 to address inflation.
   • The goal was to slow demand growth, allowing supply to catch up.

2. Headline PCE Inflation:

   • Peaked at 7% in June 2022, then declined to 3.3% by July 2022.
   • Global events, like Russia's war against Ukraine, influenced these changes.
   • Headline inflation reflects the direct experience of households and businesses.

3. Core PCE Inflation:

   • Excludes volatile food and energy prices.
   • Peaked at 5.4% in February 2022, then decreased to 4.3% by July.
   • Two months of positive data is just the start; more is needed to ensure sustainable decline.
   • The goal is to achieve price stability.

4. Core Goods Inflation:

   • Has seen a significant decline, especially for durable goods.
   • The motor vehicle sector exemplifies this trend, with prices spiking during the pandemic due to demand-supply imbalances.
   • As the pandemic's effects lessen, supply improves, and demand decreases due to higher interest rates.
   • Restrictive monetary policy is essential for continued progress.

5. Housing Sector Inflation:

   • Interest rates greatly influence this sector.
   • Mortgage rates doubled in 2022, leading to decreased housing starts, sales, and house price growth.
   • Growth in market rents began to decline.
   • Measured housing services inflation, reflecting all rents, has started to decrease but lags behind market changes.

6. Nonhousing Services Inflation:

   • Makes up over half of the core PCE index.
   • Includes services like health care, food services, and transportation.
   • Inflation in this sector remained stable since liftoff but has shown a decline over the past three to six months.
   • This sector is less affected by global supply chain issues and is less sensitive to interest changes.
   • The labor-intensive nature of these services and a tight labor market have influenced inflation here.
   • Restrictive monetary policy will be crucial for balancing supply and demand, reducing inflation in this sector.

Outlook: (A look ahead)

1. General Perspective:

   • The unwinding of pandemic-related distortions will continue to reduce inflation, but restrictive monetary policy will play a significant role.
   • Achieving a 2% inflation rate will likely need a period of economic growth below the trend and some relaxation in labor market conditions.

2. Economic Growth:

   • Restrictive monetary policy has led to tighter financial conditions, pointing to growth below the trend.
   • Real yields have increased, bank lending standards have become stricter, and loan growth has decelerated.
   • Indicators like slowed industrial production growth and reduced residential investment expenditure suggest a slowing economy.
   • However, there are signs that the economy might not be cooling as anticipated, with GDP growth exceeding expectations and consumer spending being particularly strong.
   • A resurgence in the housing sector and consistent above-trend growth might necessitate further monetary policy tightening.

3. The Labor Market:

   • The labor market has been rebalancing over the past year, but the process isn't complete.
   • Labor supply has improved due to increased participation from workers aged 25-54 and a return to pre-pandemic immigration levels.
   • The labor force participation rate for prime-aged women reached a record high in June.
   • Although job openings remain high, they are decreasing, and payroll job growth has significantly slowed.
   • Total hours worked have remained stable, and the average workweek has returned to pre-pandemic levels, indicating a normalization in labor market conditions.
   • Wage pressures have reduced, with wage growth slowing across various measures. However, real wage growth has been on the rise as inflation decreases.
   • The expectation is for the labor market rebalancing to persist. If labor market tightness doesn't ease, it might necessitate a monetary policy intervention.

Uncertainty and Risk Management along the Path Forward: (the Challenges)

1. Inflation Target Commitment:

   • The inflation target is set at 2%.
   • The goal is to establish a monetary policy that is restrictive enough to reduce inflation to this target over time.
   • Determining when this stance is achieved in real-time is challenging.

2. Real Interest Rates and Policy Stance:

   • Real interest rates are currently positive and exceed mainstream estimates of the neutral policy rate.
   • The current policy is seen as restrictive, exerting downward pressure on economic activity, hiring, and inflation.
   • The exact neutral rate of interest is uncertain, leading to ambiguity about the precise level of monetary policy restraint.

3. Lags in Monetary Tightening Effects:

   • The effects of monetary tightening on economic activity and inflation are delayed.
   • Over the past year, the policy rate has been raised by 300 basis points, with a 100 basis point increase in the last seven months.
   • The size of securities holdings has also been significantly reduced.
   • The varied estimates of these delays suggest potential further impacts.

4. Supply and Demand Dislocations:

   • This cycle's unique supply and demand imbalances complicate the effects on inflation and labor market dynamics.
   • Job openings have decreased without a corresponding rise in unemployment, indicating a significant demand for labor.
   • Inflation appears to be more sensitive to labor market tightness than in recent decades.
   • It's uncertain whether these dynamics will continue, emphasizing the need for flexible policymaking.

5. Balancing Risks:

   • Policymakers face the challenge of weighing the risk of over-tightening monetary policy against under-tightening.
   • Insufficient tightening could lead to persistent above-target inflation, necessitating more aggressive measures that could harm employment.
   • Over-tightening could also damage the economy unnecessarily.

There has not been a great move in Fed pricing. However, there is a dovish response to the speech despite the Fed Chairs insistence that the inflation still needs to come down and the economy remains strong with GDP.