Using Powell’s Past Language to Predict His Next Move

The latest Fed meeting is underway. A new natural language processing model that studies “Fed Speak” may tell us what’s next.

Updated1 May 2024, 06:30 AM IST
Using Powell’s Past Language to Predict His Next Move
Using Powell’s Past Language to Predict His Next Move

(Bloomberg) -- Listen to the Big Take podcast on iHeart, Apple Podcasts, Spotify and the Bloomberg Terminal. 

At the end of last year, the Chair of the US Federal Reserve hinted at cutting interest rates – staving off an expected recession. It was a welcome surprise for many people watching the markets. Five months into 2024, he’s poised to pivot again. 

On today’s Big Take, host David Gura talks with Fed editor Kate Davidson and Bloomberg Economics’ Anna Wong about the Fed’s latest moves and what to expect from this week’s Federal Open Market Committee Meeting.

Read more: What 60,000 Headlines Say About the Fed’s Next Move

Further Listening: The Federal Reserve's Tricky Economic and Political Terrain, Explained

Listen to the Big Take podcast every weekday and subscribe to our daily newsletter

Here is a lightly edited transcript of the conversation:

David Gura: As Federal Reserve policymakers meet this week, in Washington, they’re coming to terms with the fact that their fight against high inflation has gotten harder – and more complicated.

That’s because of new economic data showing persistent inflation, sure. 

But it’s also because of something Fed Chair Jerome Powell did. Or rather, something he said to reporters at the end of a previous meeting – back in December:

Jerome Powell: The question of when will it become appropriate to begin dialing back the amount of policy restraint in place, that, that begins to come into view, and is clearly a discussion – topic of discussion out in the world, and also a discussion for us at our meeting today.

Kate Davidson: We thought, wow, that's pretty explicit.

Gura: That’s Kate Davidson. She oversees Bloomberg’s coverage of the Federal Reserve. 

Davidson: The fact that he was sort of so clear that they were at this, this turning point, it, it did surprise all of us.

Gura: That admission in December – that Powell and his colleagues felt comfortable enough about what they’d achieved to talk about cutting interest rates – also surprised Wall Street, and investors welcomed that change in tone from the Fed chair. 

Nathan Hager: There is plenty of fuel for optimism in the U. S. market with the Federal Reserve signaling this week that it is in fact ready to start thinking about cutting interest rates next year.

GURA: At a time when many economists expected the U.S. was headed for a recession, Jay Powell pivoted, and in a new analysis, Bloomberg Economics says the Fed chair did that at the “perfect moment” to stave off a recession. 

But that pivot, in retrospect, also had other consequences. That’s because the boost to growth — which was good news — also gave a bump up to inflation — which is bad news.

Powell is in a tough position, trying to pivot again under difficult circumstances. 

And if he’s not successful, forget the elusive “economic soft landing.” Bloomberg Economics says the outcome of the Fed’s fight is likely to be “harder and bumpier than many in the markets expect.”A two-day meeting of the 12-person Federal Open Market Committee is underway, and after it ends, on Wednesday, Jay Powell will take questions from reporters.

Wall Street is going to scrutinize everything the Fed chair says about what he and his colleagues are thinking about the economy, and what’s next.On today’s show I talk to editor Kate Davidson and Anna Wong, of Bloomberg Economics. 

About how that surprise pivot may lead to another one, the challenges the Fed chair faces, and what to listen for when he speaks. 

This is the Big Take, from Bloomberg News. I’m David Gura. 

Davidson: In December, I think most people were quite surprised when he came out and gave a pretty clear indication that Fed policymakers were starting to think about cutting rates.

Gura: Kate Davidson of Bloomberg News.

Gura: A big pivot I've seen referred to as a dovish pivot. And for those of us who don't cover the Fed day in and day out, what is a dovish pivot?

Davidson: Right. So, when we're talking about the Fed, hawks tend to favor, um, higher borrowing costs to make sure we're getting inflation down. Dovish means that, um, you might be thinking a little bit more about the labor market, um, and, and wanting to make sure that borrowing costs, interest rates are not so high that they're starting to lead to an undue rise in unemployment. So when we say that Fed officials were becoming and chair Jerome Powell is becoming more dovish, that means that we are seeing the attention turning toward the possibility of lowering those borrowing costs to make sure that the economy doesn't tip over into a recession basically.

Gura: How quickly did you recognize that the Fed chair was speaking in a different way about the economy and the path forward for the Fed?

Davidson: As he kept going, we thought, wow, that's pretty explicit. I mean, something that Jay Powell is known for is being pretty plain spoken. Um, and he wants to make sure that people understand what he's saying. At the same time, usually they like to keep their options open.We assumed he would be a little more, um, just, um, a little more vague.

Anna Wong: Fed communications is very nuanced and, uh, and, and, you know, You, you certainly can be an expert of the English language, but you could still not be able to decipher Fed speak because the Fed speak with a very specific, uh, in a very specific way.

Gura:  Anna Wong is the chief U-S economist at Bloomberg Economics, and one of the brains behind Bloomberg Economics’ Fed sentiment index. 

That’s a natural language processing algorithm.

Wong: You take all these headlines generated by Bloomberg editors and reporters that captured the key essence of Fed, uh, Fed officials, speeches, scrums or testimony or tweets, you know, the entire universe of Fed speak and distill it into the core component that market traders need to know.

Gura: I'd love for you to step back from, from the model itself, maybe put on your, just your, your, your economist hat and just give me a sense of how big a surprise it was that Fed chair Jerome Powell changed his tone at that meeting. 

Wong: Well, David, I always wear my economist hat.

Gura: Of course, of course

Wong: But, however, the size of that dovish surprise. Uh, was surprisingly large in the model. So our model allows us to. Distill like the relative magnitude of that surprise. And amazingly that dovish surprise is even larger than the dovish surprise, uh, right after the SVB collapse in March of 2023. So, uh, that tells you how big it is.

Wong: It's one of the biggest, uh, dovish shock in this entire rate hike cycle. 

Gura: And that shock … came at a really critical moment. 

Wong: At that time, there was a split in, and how market commentators were reading the economy. There's one camp, ourselves, including in this camp, that thinks that the economy is probably in the midst of a recession starting in October. Um, and then, um, and then there's the other camp that thinks, in fact, the economy is strong all along, and the Fed did not have enough monetary incentive restraint. We did think that if Powell were to unleash a dovish pivot, that would ease financial conditions and immediately support the economy.

Gura: The dovish pivot effectively had a huge stimulative effect. Here’s Kate Davidson again: 

Davidson: I think it immediately gave people, um, assurance or reassurance that, um, a recession was not, um, imminent. The Fed was, um, had kind of signaled they were willing to do what was necessary to protect the labor market at this moment where people were starting to worry, geez, rates are very high. There's also this idea that monetary policy. It takes a while to work its way through the economy. 

Gura: Could you talk a bit about the way that this is, kind of, in hindsight, made the Fed's job trickier.

Davidson: Financial conditions loosened quite a bit, and that's always the risk because Fed officials, what they think they want to do is they raise interest rates. They tighten financial conditions, um, to get them to a point where they're constraining the economy. But once they had stopped doing that, they they kind of want to keep them where they're at, right?

They don't want them to get too much tighter or too much looser, and so it's a careful, it's a very careful balance. 

Gura: So, while that pivot may well have pushed back a recession, that new analysis, by Bloomberg Economics, concludes it raised the rate of inflation by half a percentage point. 

That’s after the break. 

Gura: We’ve been discussing the Federal Reserve’s latest moves, and what to expect from policymakers this week, with Anna Wong, of Bloomberg Economics, and Kate Davidson, of Bloomberg News.  

Gura: Kate, What were the first signs in 2024 that maybe Fed Chair Powell had made a mistake, he'd pivoted too early?

Davidson: Well, it's hard to say because as economists often say, and as economics reporters, we sort of subscribe to this, that you can't take a lot from one data point. So we did see that, you know, inflation in January was a little firmer, firmer than people expected. Saw that again in February, saw that again in March.

And then I think it's like three, you know, three points it can be connected to make a trend. And late last year, um, yeah. Chair Powell and some of his colleagues that had said things like, look, we don't have to see a better number every single month, month to month, but we have to continue to see more of what we've seen.

Gura: And it looks like the Fed chair has started to pivot again, already. Two weeks ago, at an event on the sidelines of the International Monetary Fund’s Spring Meetings in Washington, Powell said this: 

Powell: The recent data have clearly not given us greater confidence, and instead indicate it's likely to take longer than expected to achieve that confidence.

Davidson: If they've effectively reset the clock on rate cuts because they want to see better inflation data, you presumably they want to see a few months of data.

GURA: What economists and investors will be listening for, on Wednesday, is for the Fed chair to pivot even more. It’s a big opportunity for him to do that.

I think people will be listening closely for how much more data, uh, how do you want to see before you're comfortable cutting rates?

But if he says something like three months, I mean, May, June and July. I mean, there's not, there's not a lot of time for them to make that decision. So the question is, is that enough to give them enough confidence?

But if they don't have that confidence by July, then you have Jackson Hole in August, where the Fed chair typically makes a big, a big speech. That'll be a moment for him to kind of potentially signal one way or another, whether they're ready and then September. That's awfully close to the presidential election. 

Gura: Kate, how good is the insulation the Fed has from the politics? What's your sense of how much pressure this institution is under and how much more that pressure is likely to build as we get closer to November?

Davidson: I do think the pressure is going to build and I think it's important to note that it's not just coming from the right.

I mean, there are Democratic lawmakers who have complained that the Fed should be cutting interest rates. 

So I think that that will definitely pick up from both sides as we get closer to November. But I think that, um, Chair Powell has shown that he is pretty good at navigating all of that.

Something that, let's say that he has put a lot of time and effort into is building relationships with lawmakers on Capitol Hill. And that was hugely to his benefit during the Trump administration because even while he was, um, taking a lot of incoming from the White House, Republicans on, um, Capitol Hill defended him, essentially, they had his back and I think that that was, that was a big help because ultimately the Fed, it was created by Congress and Congress oversees the institution and that's who, uh, that's who Powell has to answer to.

The Fed chair is nominated by the president and Chair Powell was nominated by President Trump, but he's confirmed by the Senate. 

Gura: Kate Davidson and her team of reporters are covering this week’s meeting, and they’re also keeping an eye on how Wall Street reacts: 

Gura: At this moment, with this Fed meeting underway, what are markets expecting now about what the Fed is going to do in the remainder of 2024?

Davidson: This is actually really interesting. Markets have dialed back expectations a lot. They were almost more hawkish than the Fed itself was, uh, at least when officials met in March. So markets now see, um, between one and two cuts in 2024, and they don't expect the first cut to come until much later in, in the year. 

And that is, I think, in large part because of this sort of surprising, surprisingly strong, surprisingly hot inflation data that we've gotten at the beginning of the year.

Gura: What are you listening for, what do you expect the Fed chair to say when he addresses reporters on Wednesday?

Davidson: Well, I think the thing about this me, this meeting in May is that fed officials don't have to put down on paper where they see rates heading.  I don't think that he's going to commit one way or the other. He's going to lean heavily into the idea that they just have to see what the data show, which is something it feels like it's kind of like a broken record.

He has said it over and over and over and over again. Um, this time he doesn't, he doesn't have to say anything else. I think he's going to not commit, uh, to a plan one way or the other.

Gura: Anna, you mentioned that your model is predictive. What is it telling you now?

Wong:  The model is saying that if, the if Powell does not do a hawkish pivot to reverse his December pivot, then unemployment rate would be declining. And inflation will be 0. 5 percentage point higher. However, if he does decide to, um, do, uh, add hawkish surprises that in the next two months, then unemployment rate would be back on track to rise toward 4.5 percent at the end of the year.

Gura: Is it accurate to say that the change in tone in December made the Fed's job more difficult, made this fight against high inflation more difficult? 

Wong: Yes.

As a policy makers, you really don't want to turn the economy into like a yo-yo ball where like, it's never good when the asset market is like running up by a crazy amount, and then you have to do something to burst this bubble because bursting the bubble create volatilities, create uncertainty, and it's, it's a path where things are moving gradually is always preferable to things going up and down and up and down, right? So I think from the Fed's perspective, this is, this is not a good sign. And, uh, inflation also has an inertia of its own. And so if, if the longer that inflation is away from the Fed's 2%, the more entrenched inflation will be in people's mind.

And later on, it will be harder for the Fed to bring inflation back down to 2%. So there is actually a clock ticking, um, in, in terms of bringing inflation back to 2%.

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First Published:1 May 2024, 06:30 AM IST
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