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Powell unveils new Fed strategy on inflation

Federal Reserve Chairman Jerome Powell unveiled a new framework of thinking for the central bank that will tolerate inflation “moderately” above its 2% target. Michael Purves, Founder and CEO at Tallbacken Capital Advisors, joins Yahoo Finance’s Akiko Fujita to discuss.

Video Transcript

AKIKO FUJITA: Let's start with the big story from the Fed today and that shift in its inflation framework. Chair Jerome Powell laying that out, laying out his case earlier at the Jackson Hall-- Jackson hole symposium. Take a listen.

JEROME POWELL: We continue to believe that specifying a numerical goal for employment is unwise, because the maximum level of employment is not directly measurable and changes over time for reasons unrelated to monetary policy. The significant shifts in estimates of the natural rate of unemployment over the past decade reinforce this point. In addition, we have not changed our view that a [INAUDIBLE] inflation rate of 2% is most consistent with our mandate to promote both maximum employment and price stability.

AKIKO FUJITA: Let's bring in Michael Purves. He is a founder and CEO at Tallbacken Capital Advisors. Michael, it's good to have you on today. I'd love to just start by getting your thoughts on what we heard from the Fed chair there in terms of the shift in this inflation framework, certainly very well telegraphed. But it seems like investors are sort of trying to feel it out today, just given the choppy trade.

MICHAEL PURVES: Yeah, I mean, I think one of the things that we've really been living through since March-- obviously COVID, right? But in terms of Fed policy, we've seen an incredible shift. Powell's always been sort of data dependent. It sort of defined the first couple of years of his-- of his role as Fed chairman. And what seems to be evolving is an evolution of how he's thinking about the Fed's-- on a more strategic basis.

Before we just get into today, I mean, one thing I would point out is that in June at the FOMC, the median dots for employment were actually better than the Street's consensus. The GDP numbers for '21 and '22 were better than the Street's consensus. And yet 14 of the 16 participants from the Fed had zero rates for through the end of 2022.

And so I think what's happening a little bit is-- just to start this discussion is that the Fed has started becoming less data dependent. And they're more sort of strategic about just keeping-- look, we are-- we could act in shock and awe. We will keep rates for as low as we deem necessary. And that's looking like to be a very long time.

What I think we learned today is that they're even taking that-- nudging into-- nudging that even further along with that clip you just played about the employment rolls and all that. And I think there's a lot of logic to that, to understanding employment in a more thorough and robust way and not relying on some of the metrics that are decades-old. We certainly saw that after the big financial crisis, for example, with a lot of the-- with Phillips curves just not working the way they had in previous cycles. So I think he's giving himself basically more room to keep rates super low for even longer, regardless of what type of employment trends we might see, or, for that matter, whether inflation runs hot, meaning above 2%, for a while.

AKIKO FUJITA: Michael, one of the questions this is by allowing inflation to run hot, I mean, how far ahead is the Fed going to tolerate inflation? We heard Dallas Fed President Robert Kaplan telling CNBC that he would not be comfortable with a 3%. But 2.2% to 2 and 1/2%, he'll be fine. I mean, what we heard today doesn't necessarily lay out how far that line is. So how do you interpret that?

MICHAEL PURVES: I mean, that's-- it's a great question. And it's sort of the $64 question, is what is the reaction function of the Fed if we suddenly saw actual inflation at 2 and 1/2% or 3%? And how long does it have to stay there for them to really pivot?

It's sort of right now an unknowable question. And I'm guessing the Fed doesn't know the answer to that question either. I think it will also be interesting to see that if break-even inflation rates, if the difference between nominal treasuries and the inflation-protected treasuries, if that-- that rate of expected inflation has been climbing steadily. It's actually back to you know February levels, pre-COVID levels.

If that continues to accelerate, it will be very interesting to see how the Fed reacts to that. What if that gets above 2% by December, for example? Or if it even gets to 2 and 1/4%? That will be very, very interesting, because the Fed does look at that metric quite frequently there.

But I think what Powell seems to be saying this morning is that look, we have done a lot to get inflation hot in the past. We've never really gotten that hot. And right now, with that as a backdrop, if we see any up-- real sort of acceleration in inflation, actual or market-based, as ultimately probably being transitory, not something we really need to be too upset about or concerned about, and requiring us to change things.

I think that is a-- that's-- that is one of these questions which I think is going to be really looked in to by the bond market very carefully, because what's different this time than in 2010, '11, '12, '13, and so forth, is that we have this sort of collision of very aggressive fiscal policy with very aggressive monetary policy at the same time. After the financial crisis of 2008, we got a huge amount of monetary policy, although it came in more staggered sort of-- it came in a little bit more lump-- in a more lumpy fashion. The fiscal policy really wasn't that aggressive--

AKIKO FUJITA: Michael?

MICHAEL PURVES: --back then.

AKIKO FUJITA: Let me ask you this, for what this all means from a market perspective. I mean, is this essentially a green light for investors to put more money into equity? We've already seen huge swings in bond yields. But given that there's still some cash sitting on the sidelines, what do you say to those investors who are saying, well, if rates are going to stay low for a very long time, where should we be finding yield?

MICHAEL PURVES: Well, I think, first, the bond market's been selling off today. I think that you can ascribe all sorts of narratives to it. I think it's really a lot of sell-the-news. I think so much of this was priced in to this.

And he said something that was very, very dovish, something-- he was-- look, a variation of we're not even thinking about thinking about thinking about raising interest rates right now was sort of what he was saying today. And yet the bond market sold off. Part of that may to delay if inflation really starts getting ugly, that the bonds are going to sell-- the market's going to sell the bonds, even if-- even if Powell is going to keep buying them there. So I think that's part of it. But I think most of it's sell-the-news there.

But look, in terms of equities, I just reaffirmed my year-end price target of $36.50 just a couple of days ago. If bond yields-- they'll move around here. But let's say that the 10-year yield is 60 to 80 basis points, even up to 90 basis points. If it's going to stay there and really not get any more dramatic than that, then I think equities-- what we're seeing here is sort of underwriting the bull market in equities.

And so we'll probably get some dip in the near-term. But that dip probably gets bought, assuming Powell keeps this strategy going, which he probably will.

AKIKO FUJITA: OK, Michael Purves, always good to talk to you. Appreciate your time.

MICHAEL PURVES: Thank you.