“So let me start by saying that the inflation that we got was not at all the inflation we were looking for or talking about in the framework. This was—it really was a completely different thing.” Jerome Powell, December 2021.
Transcript of Chair Powell’s Press Conference — December 15, 2021
Statements like this make us wonder if calling somebody a “central banker” ought not to be taken as an insult. That was Chair Powell at the post FOMC press conference back in December 2021. They wanted inflation, badly! That was the whole point of ZIRP, QE, LSAPs, and FAIT. These were all policies that were innovated, in just the last decade or so, with the expressed purpose of pushing prices back up to their annual +2% target, and beyond. When they achieved what they worked so hard for, instead of taking a victory lap, they claimed that wasn’t the inflation they were looking for!
Figure 1: US Price Indices YoY%: CPI (white), Core CPI (blue), Core PCE (papaya) vs Fed Funds (purple) and Federal Reserve Total Assets (yellow, left-scale). 2% Target (red dash). August 2020 (green vertical) and November 2021 (red vertical). 2012 – July 2025
Source: Bloomberg, Convex Strategies
We raise this because Chair Powell took the opportunity of the annual Jackson Hole gathering to announce the release of the Fed’s revised “Statement on Longer-Run Goals and Monetary Policy Strategy”, aka their framework review.
Speech by Chair Powell on the economic outlook and framework review – Federal Reserve Board
Just quickly to summarize, Chair Powell stressed these four points per the revision to the framework.
- They removed language indicating that they had elevated the ELB (Effective Lower Bound) as the defining feature of the economic environment. Noting that “monetary policy strategy is designed to promote maximum employment and stable prices across a broad range of economic conditions.”
- They dropped the Flexible Average Inflation Targeting, eliminating the “makeup” strategy. Noting that “the idea of an intentional, moderate inflation overshoot had proved irrelevant.” The new framework stresses the importance of anchoring inflation expectations.
- They removed the reference to maximum employment “shortfalls”, which itself had replaced “deviations”, to go to wording that allows pure discretion under any circumstance. The new wording states “the Committee recognizes that employment may at times run above real-time assessments of maximum employment without necessarily creating risks to price stability.”
- They returned to language more similar to the original 2012 framework as regards the balance between their employment and inflation objectives when they are not complementary. Again, just giving themselves more discretion.
Here is the link to the actual framework.
Statement on Longer-Run Goals and Monetary Policy Strategy
Regular readers will be aware that we have discussed the coming framework review in past Updates; November 2024 –“Rationality Wars” Convex Strategies | Risk Update: November 2024 – “Rationality Wars” and March 2025 – “Moral Hazard” Convex Strategies | Risk Update: March 2025 – “Moral Hazard”. In the “Moral Hazard” note, we referenced three Brookings Papers on the topic. The suggestions in these papers very much aligned to the final outcome.
The major change, obviously, is the removal of FAIT. Chair Powell, as has become tradition amongst central bankers, made it clear in his Jackson Hole speech that FAIT had nothing to do with the subsequent inflation of 2021-2023. One would be excused for thinking that they removed FAIT, not because its “makeup” strategy allowed inflation to get out of control but, rather, because it just wasn’t necessary. Inflation came along and shot well above their measure of stability all by itself, independent from their extraordinary policies to generate inflation.
One thing notably absent in the framework review is any mention of QE and the various uses of the Fed’s balance sheet. Whatever the Fed was hearing, in their various “listening” events, as relates to QE and asset purchases, it did not find its way into the framework review. There has been a fairly vocal chorus as to the concept that QE might be an acceptable emergency, cum financial stability, tool but its use as a monetary policy tool might come with too many unintended consequences. We have been known to state as much ourselves.
One noteworthy voice decided to pen just that, along with a few other criticisms of the Fed, in a post-Jackson Hole Wall Street Journal op-ed, that being US Treasury Secretary Scott Bessent.
The Fed’s ‘Gain of Function’ Monetary Policy – WSJ
“At the heart of independence lies credibility and political legitimacy. Both have been jeopardized by the Fed’s expansion beyond its mandate. Heavy intervention has produced severe distributional outcomes, undermined credibility and threatened independence. Looking ahead, the Fed must scale back the distortions it causes in the economy. Unconventional policies such as quantitative easing should be used only in true emergencies, in coordination with the rest of the federal government.” Scott Bessent, September 2025.
Yikes! That’s a far cry from 2021 when Chair Powell and then Treasury Secretary Janet Yellen stood shoulder to shoulder in their narrative that the inflation was “transitory”. They stuck firmly together in this consistent narrative until late in the 4th quarter of 2021, both eventually announcing they were ready to “retire the word transitory”, within just a couple of days of each other, coincidentally just a week or so after Chair Powell was reappointed for another term. Most Sharpe World commentators today are loudly calling for the days when the Fed and the Treasury could return to that sort of alignment, what said commentators commonly refer to as “independence”.
When it comes to rising prices, persistent seems more apropos than transitory.
Figure 2: US CPI Index. 1970 – July 2025 (normalized). 10yr Forward Projections at Target 2% (green dash) and Current 2.75% (red dash)
Source: Bloomberg, Convex Strategies
As an aside, John Cochrane coined a very nice note on the topic of Fed independence, comparing duelling notes from both sides of the political spectrum: Democrat Senator Elizabeth Warren and Republican appointee Fed Governor Stephan Miran. John, and we suspect most readers, was surprised by how similar the views were from both sides. As is often the case, John’s own comments closely parallel much of our own thinking on the topic.
The Institutional Structure of the Federal Reserve
“Independence must compromise with accountability. Independence slows down the popular and political will but does not stop it. Independence comes with a limited mandate (price level, employment, and financial crises, nothing else), limited tools (originally, short-term interest rates and small treasury purchases), and periodic review including appointments. An agency can be more independent the more its activities do not resemble transfers, as that is the essence of politics…Restore Fed independence by restoring limits on its activities. If it’s interfering politically in fiscal policy, credit allocation, bank regulation, and other areas, then tighten the limits on mandate and tools rather than accept the current much broader set of interventions but add more political direction — sorry, “democratic accountability.” I prefer the “democratic accountability” to lie in better defining the rules of the game, and less in telling the Fed which piece to move.” John Cochrane, August 2025.
Back to Jackson Hole where Chair Powell also touched on the current state of policy and economic affairs. The market generally took his comments as dovish, focusing particularly on his continued claims that current policy is restrictive.
“Our policy rate is now 100 basis points closer to neutral than it was a year ago, and the stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance. Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.” Jerome Powell, August 2025.
We asked one of our friendly AI tools if it was accurate to couch the current policy stance as restrictive and, if so, how would one justify that. The AI confirmed that the policy stance is indeed restrictive and justified it because the Fed said so. Oh well…
Far more interesting than Chair Powell’s spin was the overall theme of this year’s Jackson Hole gathering – “Labor Markets in Transition: Demographics, Productivity, and Macroeconomic Policy”.
Anything with demographics on the agenda is music to our ears! The key points related to demographics came during the featured panel discussion with ECB President Lagarde, Bank of England Governor Bailey, and Bank of Japan Governor Ueda.
First up, President Lagarde.
Beyond hysteresis: resilience in Europe’s labour market
The focus in her presentation was on the resilience in employment even as the ECB went through an historically extreme monetary tightening in their fight to restore price stability. One of the areas she stressed was on the, somewhat surprising, ability to grow the labour supply over the period. This is somewhat surprising given the known demographics issue of declining working-age population. The growth of labour force was achieved by an increase in participation by both women and older individuals, along with, more significantly, foreign workers. She notes that foreign workers accounted for half of the growth in the labour force over the last three years.
She notes, even with continued migration, it will not be possible to fully offset the coming declines in working-age population. She also expresses concerns on continuing trends towards poor productivity gains. The chart below reflects these points.
“Migration could, in principle, play a crucial role in easing labour supply constraints in selected regions. But in all plausible scenarios – even those assuming high migration – the euro area’s working-age population will continue to shrink…these same forces could weigh on labour productivity.” Christine Lagarde, August 2025.
Figure 3: Europe Demographics and Productivity
Source: 2025-08-23-Jackson_Hole_Madame_Lagarde.pdf
Governor Bailey, likewise, reflected upon the demographic declines in working-age population and weaker productivity gains. His chart on declining working-aged population also included the other side of the key dependency ratio, the growth in retirement-aged population.
Figure 4: UK Working-aged population vs Retirement-aged population
Source: bailey_projector.pdf
Figure 5: UK Labour Supply and Labour Productivity
Source: bailey_projector.pdf
Finally, and we might argue most significantly given Japan’s earlier and deeper advancement into the demographics of working-age population declines, we get to Governor Ueda’s speech, “Japan’s Labor Market under Demographic Decline: Evolving Dynamics and Macroeconomic Implications”.
Japan’s Labor Market under Demographic Decline: Evolving Dynamics and Macroeconomic Implications
Japan was earliest to get to peak working-age population, hitting the point back in 1995.
Figure 6: Japan Total and Working-age Populations
Source: https://www.kansascityfed.org/documents/11211/Ueda_projector.pdf
Ueda-san, contrary to his fellow panellists, takes some credit for the rising inflation noting the impact of their policies, along with the post-COVID-19 global inflation, for bringing the inflation they have long desired. He shows the below picture of CPI (less fresh food) and base pay increases that very clearly displays the significant, and sustained, rise in those indicators relative to what has been seen over the past 25 years.
“The large-scale monetary easing since 2013, together with post-COVID-19 global inflation, has finally pushed inflation into positive territory. Wages are now rising, and labor shortages have become one of our most pressing economic issues.” Kazuo Ueda, August 2025.
Figure 7: Japan Core CPI and Base Pay Increases
Source: https://www.kansascityfed.org/documents/11211/Ueda_projector.pdf
Disappointingly, Ueda falls back upon his crutch of “perceptions” in the critical discussion about the future implications of working-age population declines and the challenges to sustain the labour supply in the face of already historically high increases in participation rates for women and the elderly. The below graphs show clearly how pulling women and seniors into the labour market offset the decline in working-age population since 1995. Forward projections now predict that that will no longer be the case and from here onwards there will be an ever-declining pool of employed persons.
“Whether population decline leads to tighter labor markets and higher wages depends on how it is perceived by households and firms as well as on other drivers of the dynamics of the economy.” Kazuo Ueda, August 2025,
Figure 8: Japan Labor Force Participation and Labor Supply
Source: https://www.kansascityfed.org/documents/11211/Ueda_projector.pdf
We would opine that the impact on the tightness in labour markets and higher wages depends much more on reality than mere perceptions. Governor Ueda also mentions the impact of foreign workers, similarly noting that they have contributed to 50% of the growth in the labour force over the last two years. In a nod to the political sensitivity on the topic he caveats his comment with – “Further increases would require a broader discussion”.
We want just to quickly touch on one of the academic papers presented at Jackson Hole.
An interesting paper on asset supply and demand looking at the implications from demographics change on fiscal sustainability (something that we too have been doing some bottom-up research on).
The Race Between Asset Supply and Asset Demand0.5cm
“We propose a new asset supply-and-demand framework to study historical and future trends in aggregate wealth, r ∗ , and fiscal sustainability. If asset supply wins the race, interest rates rise, and if asset demand wins, they fall… We use this framework to analyze the implications of demographic change for fiscal sustainability. On the one hand, an aging population increases government outlays on healthcare and social security payments. On the other, an older population demands more government debt. This implies that there is space for the government to finance its additional outlays by increasing its debt. Our calculations suggest that, in 2100, the U.S. could sustain a debt-to-GDP ratio of 250% at the same interest rates as today. However, achieving this requires a fiscal adjustment of 10% of GDP or more in every plausible scenario. The longer this adjustment is delayed, the more government debt supply outstrips its demand, eventually making government debt unsustainable.”
The authors try to paint a fairly rosy picture of the sustainability of a complicated situation. Their conclusion, noted in the above quote, says it is doable, just with the small caveat of necessitating a “fiscal adjustment of 10% of GDP or more in every plausible scenario”. Our work comes to similar conclusions.
There are some good points in the discussant slides on the paper, many of which align with what would be our own criticism.
- “Budget outcomes could be much worse with a higher debt sensitivity of interest rates (DSIR).”
- “Some upside risks to desired government spending.”
- “Fiscal policymakers should recognize that welfare costs are asymmetric.”
- “Raising taxes will reduce wealth and thus asset demand.”
It is a worthwhile paper but, we would argue, it undervalues the tails. We do, however, give it credit over and above all the other discussion as it does, to some extent, get to the point that we highlighted last month Convex Strategies | Risk Update: July2025 – “Preservation”. We focused in on the key point with our suggestion that all discussions on economics, debt sustainability, monetary and fiscal policy, in places where these demographic issues are in play, should include this addendum:
“And for every year going forward there will be fewer taxpayers.”
Fewer taxpayers, in a realm of growing government support (eg retirement and health care), means ample continued supply of assets, in the language of the above paper, and less asset demand. Fewer taxpayers, paying more taxes, in a world of rising living costs, means less left over to acquire bonds. We put it this way last month.
“Fewer workers means fewer taxpayers, which means higher deficits. Higher cost of living means less post-consumption earnings available for savings and investment. Lower investment means lower productivity. Ever greater government support of increasing retired workers, while faced with fewer taxpayers, inevitably brings the issue of fiscal dominance into play. Deficit spending grows mechanically, eventually fueling more inflation as the government finances it, crowding out yet more of the available savings from seeking productive private sector investment opportunities. It is a very dangerous loop to get caught in and it sure seems like a good chunk of the world is in it, and probably has been for the last couple of decades or so.”
We find ourselves more and more often involved in discussions around the demographics issue. It is hard to think of anything that is more critical that has been so roundly ignored. As many have heard us say, “it just makes no sense to talk about the state of the python without accounting for where the pig is/was in its path through”. The pig, in this crude analogy, representing the bulk population cohort working its way through its lifecycle. It absolutely must be a critical input into calculating initial conditions at any point in time and should certainly encourage caution in comparing past outcomes to present situations and future unknowns.
Dealing with a future full of uncertainty (all futures are full of uncertainty) is not a matter of better prediction, but rather a matter of better resilience. Author/educator Judith Rodin put it nicely in the introduction to her book “The Resiliency Dividend”.
“What is resilience? Resilience is the capacity of any entity – an individual, a community, an organization, or a natural system – to prepare for disruptions, to recover from shocks and stresses, and to adapt and grow from a disruptive experience. As you build resilience, therefore, you become more able to prevent or mitigate stresses and shocks you can identify and better able to respond to those you can’t predict or avoid. You also develop greater capacity to bounce back from a crisis, learn from it, and achieve revitalization. Ideally, as you become more adept at managing disruption and skilled at resilience building, you are able to create and take advantage of new opportunities in good times and bad. That is the resilience dividend. It means more than effectively returning to normal functioning after a disruption, although that is critical. It is about achieving significant transformation that yields benefits even when disruptions are not occurring.” Judith Rodin, “The Resiliency Dividend”, 2014.
We love her concept of the “resilience dividend”. There is so much more benefit, than just the avoidance of disaster, to being confident in your resilience. This is exactly what we mean in our investment analogy of putting better brakes on your race car so that you can, more confidently and safely, drive fast. Good brakes provide so much more than just paying off in the one unexpectedly sharp curve, though that in itself makes brakes indispensable. Brakes allow a driver to learn, to explore, to challenge the otherwise foregone opportunities of the overly cautious.
Resilience is the term we probably hear most from the best investors that we speak to. They are not optimizing to some average future expected outcome. They are building convexity to protect against the worst of outcomes so that they can actively go and explore for the unforeseeable best outcomes. Make your car resilient, reactive, positively convex, and go find what nobody else is even chasing.
As everyone knows, this is what we espouse relentlessly in terms of investment and risk management. Build explicit, asymmetric, protection into your investment portfolio and load up on highly convex, cost efficient, participating risk. Over the years we have shown all sorts of examples of “barbell racers” and given various nicknames to them. Let’s lay out a sampling and see how they look.
- Always Good Weather (AGW): 40% in SPX the S&P500 Total Return Index (SPXT Index), 40% in NDX the Nasdaq100 Total Return Index (XNDX), 20% in LongVol the EurekaHedge Long Volatility Index (EHFI451 Index).
- Dream Portfolio: 70% SPXT, 10% Gold (GLD US Equity), 20% LongVol.
- MegaBell: 70% SPXT, 10% Bitcoin (XBTUSD Currency), 20% LongVol,
- Preservation Portfolio: 50% NDX, 25% Gold, 25% LongVol.
We can compare our barbell champions against Sharpe World stalwarts of the traditional 60/40 (60% SPX and 40% US Treasury Total Return LUATTRUU Index) and Risk Parity (S&P Risk Parity 10vol SPRP10T Index). We’ve plotted their compounding lines below, commencing in January 2018 and running through August 2025 and then extrapolating a return target of 9% (the life to date return of the 60/40 portfolio) for another 15 years.
Figure 9: Compounding Paths vs Target 9% Return: 60/40 (blue), Risk Parity (light blue), Dream (gold), AGW (fuchsia), Preservation (brown), MegaBell (orange). 2018 – Aug2025. Projected Target Return to 2039
Source: Bloomberg, Convex Strategies
Put most bluntly, all of the strategies with better brakes, explicit negatively correlating LongVol, are the ones pulling ahead of the target compounding path. Supposedly sophisticated Sharpe World champion, Risk Parity, is lagging behind. Interestingly, the Risk Parity strategy, when measured as Downside Volatility, has the most risk and, when measured as Upside Beta, has the least upside participation. It has fallen prey to the destructive trap of Sharpe Ratio optimization, explicitly foregoing upside to probabilistically mitigate downside. It is an example of what not to do if your objective is compounded wealth.
The cleanest way to evaluate the relative construction of the portfolios is to look at what we call their Convexity Ratios, a simple measure of upside versus downside participation. We generate it with this simple formula: (1+UpsideBeta)/(1+DownsideBeta). Are you accelerating in the good times, and decelerating in the bad times? Are you convex?
Figure 10: CAGR vs Convexity Ratio: 60/40, Risk Parity, Dream Portfolio, AGW, Preservation, MegaBell. Jan2018 – Aug2025. Terminal Capital Bubble size
Source: Bloomberg, Convex Strategies
Explicitly protect downside and find things that participate in the upside. Better convexity, better return, better terminal capital.
It really is just common sense. In a multiplicative compounding path, negative compounds have a bigger impact than equivalent positive compounds and big numbers, in either wing, have a bigger impact than smaller numbers. You want to own things, explicit well-constructed protection on the downside that protect you from fat downside-tails, and own things that participate unbounded in upside-tails. You don’t want to optimize to some randomly made-up expected mean, explicitly capping your upside while explaining away potential downside based upon faux assumptions of stable historical correlations.
Here is a fun paper on the faux concept of diversification benefit in the realm of extremely heavy tails, “Risk exchange under infinite-mean Pareto models”.
2025Chen-Embrechts-Wang-IME.pdf
The authors pose this question:
“Suppose that there is a pool of identically distributed extremely heavy-tailed losses (i.e., infinite mean), possibly statistically dependent. Each agent (e.g., a reinsurance provider) needs to decide whether and how to diversify in this pool. Without knowing the preferences of the agents, what can we say about the optimal decisions and equilibria in a multiple-agent setting?”
Working with super-Pareto distributions, ie with extremely heavy-tailed losses resulting in infinite mean distributions, they come to the obvious conclusion that diversification is not a benefit.
“…for super-Pareto losses, the action of diversification increases the risk uniformly for all risk preferences, such as VaR, expected utilities, and distortion risk measures, as long as the risk preferences are monotone and well-defined. The increase of the portfolio risk is strict, and it provides an important implication in decision making: For an agent who faces super-Pareto losses and aims to minimize their risk by choosing a position across these losses, the optimal decision is to take only one of the super-Pareto losses (i.e., no diversification).”
If any one part of your diversified pool hits its infinite potential loss, well you’ve lost infinite. Just common sense. Of course, the inverse would also be true. Diversifying yourself, through well-constructed payoff functions, across risks where you would benefit from infinite potential tails, makes absolute sense! You want to own protection that exposes you to the benefit of infinite returns in the event of the realization of any extreme heavy-tail. Likewise, you would want to own a diversified pool of investments that would participate in extreme, infinite, upside beneficial tails. Again, explicitly foregoing the benefit of upside-tails, then relying on the assumption of faux-diversification to mitigate against associated extreme downside-tails, is not the path to compounded wealth.
As we always say, it’s just math.
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