Powell's silence fools markets as post-Covid economic changes

(Bloomberg) — For Rick Plimpton, there's no going back to the pre-Covid economy. Precision-lens maker Optimax Systems Inc. ’s CEO sees “shifting sands” in many aspects of its business.

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Finding enough workers is difficult, the prices of key inputs are highly volatile and there are long delays between ordering equipment and showing it up in Ontario on the New York company's shop floor. While there is strong support in Washington for the US chip-making industry – which uses Optimax lenses – politicians are taking note of the changed geopolitical landscape.

Many of these changes are not temporary, in Plumpton's view. Tight labor markets „will be with us for decades,” he says.

But Federal Reserve Chairman Jerome Powell isn't so sure. „The pandemic is writing the story of our economy right now,” he told House lawmakers on March 6. „We have to be prepared to be surprised in the next chapter.”

Longer-term economic projections from Powell and his fellow central bank policymakers paint a picture of little change despite supply chain, labor and geopolitical shocks in recent years.

Central banks serve as a country's economic narrator, providing explanations of economic trends and explaining why their policy fits the contours of a particular moment. The lack of an outlook from the central bank on why U.S. growth is resilient to higher interest rates sows volatility as investors have to guess how they will respond. Rate volatility makes planning difficult for households and businesses.

„Powell keeps talking about normalization and restructuring, but you can't go back to 2019,” says Jim Bianco, president of Bianco Research. „Whenever we have a big shock to the economy, like in 2008 or 2020, the economy changes.”

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Bianco, who has studied the U.S. economy and financial markets for more than three decades, ticks off a list of seemingly new aspects of the economy.

After the financial crisis of 2007-09, consumers seem more inclined to spend, either because of greater confidence in job security or a generational shift away from precautionary savings. The per capita savings rate averaged less than 4% over the past two years, and was more than 6% in the decade to 2019.

Companies now seem to be holding precautionary inventory on hand, with wholesale inventories running at a higher ratio to sales now than before the pandemic.

And then there's the job market.

At Optimax, even a profit-sharing scheme that distributes 25% of the salary and profits to employees could not attract enough workers. „Post-pandemic, we have more jobs than workers,” Plumpton says in a phone interview.

Drew Greenblatt, president of Marlin Steel Wire Products in Baltimore, has a similar challenge. As he walks through his cavernous shop floor and points out new precision tools that can turn out more parts per hour, he's eager to find skilled workers to operate them. „It's killing me,” he says. „I have this technology and it's just sitting there.”

Such events help explain why the U.S. unemployment rate is at a historic low of less than 4%, despite what Fed officials describe as „controlled” interest rates. Wage gains have continued to run north of 4% annually, having averaged 2.4% in the decade to 2019. While demand is still firm, companies are able to raise their prices as they struggle with higher wages.

For many investors, the longer the economy remains inflationary, the higher interest rates are needed. Futures trading suggests a benchmark Fed rate of around 3.5% in a few years — a full percentage point higher than Fed policymakers' latest long-term forecast to be updated at the March 19-20 policy meeting.

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Monetary policy works through the interaction of outlook, just as it works by raising or lowering interest rates. If investors understand how the central bank thinks about the state of the world, it reduces overall volatility and reduces the extra yield investors pay for risk.

In the past, Fed guidance helped shape expectations. When economic growth picked up in the 1990s, then-Federal Bank Chairman Alan Greenspan highlighted the structural acceleration in productivity as a sign that inflationary risks had receded.

Today, Powell can call on enormous evidence to gauge what post-pandemic shocks mean for the US economy. The Fed's board consists of two divisions that produce domestic and international economic forecasts, as well as a policy strategy unit based in Washington. There were more than 700 full-time equivalent employees by 2023, with a budget of $202 million.

However, there are big risks for the central bank to come to a big decision after an economic hurricane like the pandemic and the billions of dollars in fiscal and monetary policy support that followed.

Fed officials are still scarred that inflation in 2021 is a case of temporary supply chain blockages.

Today, declaring that the economy can sustain rapid growth thanks to a new investment boom risks being read as an endorsement of President Joe Biden's policies as the November election looms. Alternatively, Republicans could play to arguments that America is now in hyperinflationary and long-term interest-rate settings. Powell saw the political sensitivity firsthand this month when he noted at a congressional hearing that immigration has taken some of the pressure off the labor market. Legislators were amused by comments about him.

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Lou Crandall, chief economist at Wrightson ICAP LLC, says that moving away from a concrete view of structural economic changes „strikes me as an absolutely correct way to drive policy.”

„At a time when trends are evolving faster than your expectations, it can be difficult to be certain about what this means for policy,” says Crandall.

Even so, not all central bankers are afraid to introduce new features to the economy.

Christine Lagarde, Powell's counterpart at the European Central Bank, judged that the global economy was „entering an era of changes in economic relations and breakdowns in established order”. Last August, speaking at a conference in Jackson Hole, Wyoming, Lagarde pointed to three such gaps: changes in the labor market and the way people work, changes in energy markets and the fragmentation of the world into competing blocs. While it was unclear whether the changes were permanent, he said they were „much more persistent than we initially expected.”

When the central bank begins a new strategic review later this year, central bank policymakers will have an opportunity to present a new assessment of the underlying changes in the economy. Finally, it focused on how to continue underestimating the 2% inflation target in 2020. That proved ill-timed, as it closed just before the cost of living began to rise.

Whichever way central bankers lean this time, the challenges today are greater than in the years before the Covid-19 onslaught.

„We're still in the middle of something incredibly difficult and volatile,” said Julia Coronado, a partner at Macropolicy Perspectives LLC.

–With assistance from Edward Bolingbroke and Alex Tribo.

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