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All Eyes on Fed Chairman Powell

Why the speech at Jackson Hole could be a game-changer.
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Normally, I like to discuss charts, which are fun and visual, and I tend to avoid discussions about economic policy. However, we're about to get a speech that could turn all the charts upside down, so it's time to pay attention to the Fed. 

Fed Chairman Jerome Powell is scheduled to give a speech at Jackson Hole, Wyoming. It's widely believed that Powell will announce a change in the Fed's approach to inflation. 

The first thing to understand is the significance of Jackson Hole. In the past, the Fed has used this setting to announce significant policy shifts. 

What kind of shift are we expecting from Powell? Currently, the Fed targets an annual inflation rate of about 2%. The expected 5-year forward rate is just 1.8%. 

5-Year Forward Inflation Expectation Rate by Federal Reserve Bank of St. Louis. 

5-Year Forward Inflation Expectation Rate by Federal Reserve Bank of St. Louis. 

Powell could say that the Fed will now target an "average" inflation rate of 2%. That would mean that inflation levels higher than 2% would now be considered tolerable. 

To illustrate the concept of average inflation, let's look at the monthly changes in CPI. In each of the past two months, we've seen a 0.6% increase in CPI. If inflation maintains this pace, it'll be well above 2% annually. 

Monthly U.S. CPI Inflation by Forex Factory. 

Monthly U.S. CPI Inflation by Forex Factory. 

Now consider this in the context of the entire year. In the three preceding months, inflation actually fell. This renders the recent pickup in inflation insignificant. The average monthly increase in CPI inflation this year is just 0.05% - just barely above zero. 

Bottom line: the Fed might be willing to allow annual inflation to climb to 3% or higher, as long as the average inflation rate stays at approximately 2%. 

If Powell signals that the Fed will now pursue an average inflation target, it could be very good news for stocks, precious metals, and risk-on currencies like the euro. However, if Powell doesn't come through, those assets could be negatively impacted. 

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Ed Ponsi is the managing director of Barchetta Capital Management, and is the author of three books for publisher Wiley Finance. A dynamic public speaker, Ed has made appearances around the world, in such diverse locations as Singapore, Dubai, London, and New York. For more information about Ed and his work, click here.