What is the implication of Powell’s Speech

Fed Chairman Powell’s speech at the New York Economic Club—titled “the Federal Reserve’s Framework for Monitoring Financial Stability”—was roughly balanced in its monetary policy outlook. Powell mentioned that the policy rate was “just below the broad range” of estimates of neutral, consistent with the current level of the funds rate just below the lowest of Fed officials’ estimates of neutral (2.5%) and the minimum of the Fed’s various model estimates of neutral (2.4%). His description highlights the significant uncertainty around estimates of neutral, a theme he mentioned at his speech at Jackson Hole in August, and we note that the current level of rates is still well below median Fed official’s estimate of neutral (3.0%). Powell reiterated the balance of risks between moving too fast and shortening the expansion, and keeping rates too low and raising inflation and financial imbalance risks. Powell again mentioned the uncertainty of the effects of monetary policy as well as the data-dependent nature of policy. Overall, Powell remained constructive on the economic outlook, with the Fed close to both objectives of its dual mandate, and with the economy growing “well above most estimates of its longer-run trend.”

While Powell mentioned a connection between low interest rates and financial stability concerns, he downplayed the role of monetary policy as the appropriate tool to address financial imbalances. He also stated the equity valuations were “broadly consistent” with historical benchmarks, and that it was “important to distinguish between market volatility and events that threaten financial stability.” Powell also mentioned that while highly leveraged corporate borrowers would likely face distress in the event of an economic downturn, their losses were unlikely to pose a threat to the system as a whole, with a significant amount of lending done by non-bank vehicles such as collateralized loan obligations. Other financial risks Powell mentioned were the normalization of monetary policy in the U.S. and elsewhere, Brexit negotiations, and the Italy budget discussions.