Market Pulse: August 19, 2024

If Powell has concerns about the Unemployment Rate, then his Jackson Hole speech might draw heavily on Greenspan’s seminal speech about risk management, presented twenty years ago.

First of all: In the last fifty-five years, in the three months following the month when the Unemployment Rate rose to a level that was 0.9% to 1.0% above its cycle low, the rate accelerated higher; at least by five tenths and on occasion by more than one percent. And not once was the three-month acceleration the whole story; the peak rate did not print for at least nine months and always the peak rate was considerably higher, every single time. (The red arrows on the charts below indicate 0.9% - 1.0% above cycle low.)

Second of all: The July reading of the Unemployment Rate was two tenths higher than the month before; at 4.3% the rate is 0.9% off the cycle low.

Third of all: The FOMC last met on July 31. The FOMC next meet on September 18 and the meeting after that is November 6.

Fourth of all: The last jobs report was on August 2, two days after the Fed’s last policy meeting. The next jobs report is on September 6. So, there are two jobs’ reports between the Fed’s July and September sessions.

After the Fed meets in September, but before the Fed meets in November there will be jobs reports on October 4 and November 1. So, there will be two jobs’ reports between the September and November sessions.

Based on the historical record of the last half century there is a risk that the Unemployment Rate will be at, or near, 5.0% by the time the Fed meets in early November; quite a bit more than the cycle low of 3.4%. It should also be said that Powell thinks highly of the Unemployment Rate. At the last FOMC post meeting presser he was explaining how he will judge labor market normalization and that the judgment would not depend on “…any one statistic, although, of course, the unemployment rate is generally thought to be, you know, a single---a good single statistic.”

Blame the calendar for some of the angst. As noted above, there are four reports on the Unemployment Rate, one third of the entire calendar year’s data on that statistic, bracketing just one FOMC meeting. The July and August jobless rate reports come after the July FOMC and before the September FOMC and then the September and October jobless rate reports come after the September FOMC, but before the November policy session.

That makes it very important that the FOMC does the right thing in September. Seems to me that Fed credibility will take a significant hit if the Unemployment Rate is five percent and the only thing the Fed did was cut a quarter point off the funds rate during its ascent. I don’t know if the jobless rate will soar during these months, but neither does Powell and the history is a bit ominous. By definition, a “data dependent” Fed is not able to contemplate the potential risk for the Unemployment Rate. But a Fed that shapes its policy based on “risk management” can look ahead. Alan Greenspan’s speech from January 3, 2004 was called, Risk and Uncertainty in Monetary Policy. The speech broke new ground in explaining how the Fed conducts policy.

“The Federal Reserve’s experiences over the past two decades make it clear that uncertainty is not just a pervasive feature of the monetary policy landscape; it is the defining characteristic of that landscape,” said Greenspan. “As a consequence, the conduct of monetary policy in the United States has come to involve, at its core, crucial elements of risk management. This conceptual framework emphasizes understanding as much as possible the many sources of risk and uncertainty that policymakers face, quantifying those risks when possible and assessing the costs associated with each of the risks.”

So, Greenspan says that the while the Fed may not know what is going to happen next, they can imagine a range of possible outcomes and the sliding scale of risks associated with those outcomes. “Given our inevitably incomplete knowledge about key structural aspects of an ever-changing economy and sometimes asymmetric costs or benefits of particular outcomes, a central bank needs to consider not only the most likely future path for the economy but also the distribution of possible outcomes about that path. The decisionmakers then need to reach a judgment about the probabilities, costs, and benefits of the various possible outcomes under alternative choices for policy.”

Therefore, Greenspan notes, “…policy practitioners operating under a risk-management paradigm may, at times, be led to undertake actions intended to provide insurance against especially adverse outcomes.”

It seems to me that a significant spike higher in the Unemployment Rate is an “especially adverse outcome.” It is an outcome that Powell may wish to take out insurance against. Data dependence doesn’t work for possible outcomes, but risk management does. The Fed is already expected to cut rates more than once. The unusual calendar, vis a vis the jobs reports and FOMC meetings, may make it worthwhile to frontload the onset of the easing cycle. Without actually saying he will start of the cycle with a shout rather than a whisper, Powell could talk about the benefits of Fed policy using risk management during his Jackson Hole speech.

As a result, he may be able to head off any of the negative connotations associated with starting the easing cycle with a fifty-basis point rate cut. “Oh, I get it, Powell’s not panicking, he’s managing risk…how sensible!!” Then if the history of the Unemployment Rate repeats itself once again, at least the Fed has gotten off to a running start rather than being left at the starting line, waiting for the data to confirm the “especially adverse outcome” that was somewhat predictable.