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Has the Fed’s Jawboning Policy Tool Become Irrelevant?

CAMS Weekly View from the Corner – Week ending 2/3/2023

February 6, 2023

We are unable to do justice within this edition relative to all that has transpired in the previous week throughout econ/market(s) land.  Rather than delving into details of X economic result we will go high level and examine an overarching theme that impacts all these results relative to how collective market participants process the various results. In near-term editions we will share views through the plethora of updated information in the previous week as many offer important pieces of information from a trend perspective for consideration.  For now, as offered, we go high level. Jawboning – the Fed’s Unofficial Important Policy Tool The Federal Reserve has a very important policy tool which is referred to in slang as the Jawboning tool.  This tool is their communication to various economic players and market participants throughout society.  Through their communication process they convey to said target audience that which they want them to “buy into” and to act accordingly within their various roles.  The message conveyed is you do it our way and we can all work together on this without as much blatant policy tool (think harsher interest rate policy as an example) actions than would otherwise be necessary to achieve our end goal of a 2% inflation experience again. The execution of the Jawboning tool is not meant as a plea or say a favor it is meant as a statement if not a threat.  Reduced to brass tacks it goes like this:  “Ya’ll slow it down or else we will pound you with relentless interest rate hikes to the point you will scream uncle – got it?” Credibility is the Foundation of the Jawboning Tool Without solid credibility backing up the institution there is no Jawboning tool.  A policymaker can talk all they want to include general persuasion techniques and even implied threats but without established credibility said communication falls by the wayside. Experientially speaking we all know this storyline. When a leader or an entity at large has lost most if not all credibility their words mean little.  Experientially, compare and contrast that to a leader that has rock solid credibility.  Their words carry serious weight. Through this lens we know that once credibility is lost, or severely damaged, getting it back takes exponentially more energy and consistency than its original build. The Federal Reserve at large as well as Chairman Powell and his fellow price inflation gatekeepers within the FOMC have had a major credibility issue and they have known it.  With price inflation consistently growing to multi-decade high levels for the past two years while for nearly half of that time Chairman Powell and his Fed was assuring society at large there was nothing to worry about – it was merely transitory – we know at a minimum, credibility is damaged.  In central banking credibility is its lifeblood because under it rests confidence.  When credibility and confidence is lost toward the gatekeeper of a fiat money system things can get ugly quickly!   As a result Powell and friends had to go on an all-out assault on prices with a record breaking pace of interest rate increases coupled with constant messaging (think Jawboning) backing up their actions.  Yes in working to rebuild credibility actions must be met with consistent jawboning lest the economic players scoff at their actions as – wait for it – “transitory,” sad but true.  Did Powell Miss a Credibility Building Moment? For context here all know the Fed has been raising rates through 2022 and with this interest rates generally are higher.  This is not the full story though. Since the fall season financial conditions have been loosening not tightening.  Financial conditions encompass more than just say the current mortgage rate.  Importantly though, even those have loosened since the fall season.  Interestingly, it was through the fall season and into the winter months that the Fed upped their jawboning efforts with relentless messaging on how serious they are about on-going interest rate increases.  Per market actions of collective market participants they felt different about near-future Fed actions.  It’s as though they were saying we hear you Fed but we do not believe you.  That is lost credibility defined.  Rather, said participants messaged through their market operations that the Fed would be ending rate hikes soon and cutting far sooner than the Fed believed – the opposite of Fed messaging, i.e. jawboning. There are many examples of loosening conditions but just one isolated example is within the stock market.  Since the mid-fall season the Dow Jones Home Construction Index has gone up nearly 50%!  Not a typo. Wait, all we hear about is how the housing market is crashing and if it hasn’t started yet it will any day now – a two plus year old expectation.  Market participant messaging is saying you already experienced your “housing crash” – remember participants are always forward looking.  Somebody has it very wrong and who that turns out to be will be quite interesting.  Forward looking stock market participants are jettisoning upward Home Construction stocks and in so doing loosening financial conditions for them.  Within the bond market Triple C’s (CCC and below rated corporate bonds) which are one step away from life support in good economic times have come down in yield by 3 1/4%!!  This is further evidence that financial conditions since mid-fall have been loosening on the Fed!

The above gives a visual via the Chicago Fed Financial Conditions Index.  Our red arrow highlights the consistent fall since late October in this Index which means financial conditions generally are loosening not tightening.  This has gained momentum and attention within the Fed/Market observing community. It was for this reason in our previous edition we felt a ¼% increase may not be a guarantee because market participants were so convinced of such.  Wait, what? The point is through the lens of lost credibility by the Fed and their need to rebuild it at all costs (citizen you really do not want your central bank to have little credibility even if the investor in you celebrates because your household will pay a larger price) and with this if the Fed followed through with their ¼% expectation participants would run with it by loosening financial conditions further.  For the Fed’s part, knowing what market participants would do with only a ¼% increase, would they feel it necessary to raise by ½% to drive the message home to stop loosening financial conditions generally as displayed above.  They chose a ¼% increase and participants drove conditions looser. In total then, financial conditions are loosening on a trend basis while price inflation is still historically highly elevated.  Digest that mix for a moment.  At the same time the Fed is insisting on its 2% inflation target as the objective which is a tremendous distance south of current inflation readings.  This all speaks to a strange if not illogical mix.  Something will have to give – or most probably break – for this interactive storyline to make sense again.  Where is the Fed’s credibility now?  Well if they are preaching tightening and participants are loosening it suggests credibility remains low and with this the Jawboning tool is ever less relevant.  We expect interesting market(s) based volatility (think up, down, all around) in coming weeks and months as all these cross-currents unfold. I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis


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