Powell and Federal Reserve under pressure to handle their exit from super-easy policies

Powell and Federal Reserve under pressure to handle their exit from super-easy policies

Federal Reserve Chairman Jerome Powell testifies during a US House Oversight and Reform Select subcommittee hearing on the coronavirus crisis on June 22, 2021 in Capitol Hill, Washington.

Graeme Jennings | swimming pool | Reuters

For the Federal Reserve, implementing the softest monetary policy in the institution’s history has been quite difficult. Even going out will not be a cure.

This is what the central bank faces on the road ahead.

On Friday, investors will learn more about what Fed Chairman Jerome Powell thinks about the economy, and they hope to get at least some more clues about the steps he is taking to protect the country from the central bank. How will you guide the exit? Covid pandemic19. He will be speaking at the Fed’s annual convention in Jackson Hole, which will be held again virtually this year.

First, the Fed’s record is backing down on money printing – buying bonds worth $ 120 billion or more each month in an effort to stimulate demand and lower interest rates in the long run. term.

After that, the road becomes more difficult.

At some point, the Fed will look to raise short-term interest rates from the near zero anchor where they have been since March 2020. It was not a good idea for the Fed to try last time. to bring rates back to normal. . Do it from 2015-18, because it must have stagnated mid-cycle in an economy in recession.

In such a situation, the market may have an excuse to be at least a little nervous this time around. The Fed not only needs to change its most aggressive easing policies ever, but it needs to do so with precision and hope it doesn’t break anything in the process.

“Every change in the Fed’s monetary policy is important,” said Priya Mishra, global head of rate strategy for TD Securities. “But I think it’s mostly more meaningful today because we know growth is slowing down and the Fed is trying to get out of it.”

In fact, the economy is still in a strong recovery from the depths of the pandemic, which produced the deepest but shortest recession in U.S. history. But the rebound appears to be at least a stop, if not a decline. The Citi Economic Surprise Index, which measures actual data against Wall Street estimates, reached an all-time high in mid-July but has now fallen to a previous level in June 2020 at the onset of COVID-19.

Fed officials themselves expect growth to slow significantly in the coming years, as monetary and fiscal policies tighten. This raises further questions as to whether Powell and his comrades can get the right to go out.

misunderstanding on the market

“Does it come out in the right place?” Are they coming out at the right time, in the right quantity? Given the slow economy, we have questions on both, ”Mishra said. “The market takes into account a political error. “

What Misra means by policy error is that the current pricing of Fed funds futures, which trade around the market Fed rate, indicates that the Fed will only be able to raise its rate a few times to 1. , 25%, then will have to stop as development stalls.

Rates that frighten Fed officials less because they leave them little room to relax their policy in times of crisis. This is where the funds rate fell well below the target range of 2.25% to 2.5% at the start of the pandemic crisis, where the Fed ended its last cycle of rate hikes in December. 2018.

How to handle all of this will be up to Powell from a computational communication standpoint and in terms of actual mechanics for the other members of the Federal Open Market Committee.

“The tapering is important because it is a very good measure of not only the credibility of the Fed, but also the quality of the strategy and its transparency in terms of communication,” said Deepak Puri, director of US investments at Deutsche Bank. Richness. Management. “In 2013, the Fed made mistakes in communicating about tapering. “

This 2013 episode – the so-called taper tantrum as it’s known now – is the market’s only model of how the Fed can move forward.

Misra, a strategist at TD Securities, pointed out that the Fed is already showing that it has learned a lesson from the previous episode, which is that it is now diluting the market. The 2013 announcement by then Fed Chairman Ben Bernanke was seen as abrupt, and it raised interest rates and lowered stocks for several months before reversing those trends.

Sean Snyder, Head of Investment Strategy at Citi US Consumer Wealth Management, said: “They do a good job in that they really try not to surprise the markets. . It’s positive. . “They are in a bit of a difficult situation because the delta version acts like a wildcard.”

depending on the food

The Fed and the markets have long been hip joints, but especially in the era of quantitative easing and zero interest rates that began in 2008. Stocks had fallen sharply at the start of the pandemic, but have rebounded again as the Fed raised bonds. purchases.

During the first tap, the market finally recouped its losses after the tap started and went through a cycle of rate hikes – until the end of 2018, when a series of communications from Powell shocked investors.

Balance sheet of the Fed, the stock market takes off

As the Federal Reserve builds its balance sheet, the S&P 500 index rebounds

From a covid accident to a record level

Federal Reserve Net Worth

Note: The shaded area represents the US decline. The Fed’s balance sheet data is not adjusted.

Source: Board of Governors of the Federal Reserve System via the Federal Reserve Bank of St. Louis

(Assets), FactSet (S&P 500). Data until August 18, 2021.

Fed balance sheet, stocks take off

As the Federal Reserve balances

Record, the S&P 500 index rebounded

From a covid accident to a record level

Federal Reserve Net Worth

Note: The shaded area represents the US decline. irrigated

The balance sheet data is not adjusted.

Source: Federal Reserve Board of Governors

System, through the Federal Reserve Bank of Saint-Louis

(Assets), FactSet (S&P 500). Data as of 08/18/21.

Balance sheet of the Fed, the stock market takes off

As the Federal Reserve builds its balance sheet, the S&P 500 Index

Kovid recovered from accident to reach record high

Federal Reserve Net Worth

Note: The shaded area represents the US decline. The Fed’s balance sheet data is not adjusted.

Source: Board of Governors of the Federal Reserve System, via the Federal Reserve

Bank of Saint-Louis (assets), FactSet (S&P 500). Data until August 18, 2021.

On the economy, Fed officials have focused less on their policies and more on financial aid and the path to the virus.

The stress of Covid raises doubts about the direction of development. But several regional Fed chairmen who spoke to CNBC this week said the virus had little impact on growth and was not weighing on their economic forecasts just yet.

“Consumers and businesses are becoming more adaptable, more resilient, and I think people are expecting that. [the virus] in spurts, ”said Dallas Fed Chairman Robert Kaplan, who favors phasing out political accommodations.

The informal consensus in the market now is for the Fed to start clearing up before the end of the year and complete the process in eight to 10 months. After that, it will assess whether things have held up before moving on to rates.

Landmines for Powell

Poignant political dynamics inside and outside the Fed complicate matters for Powell.

Louis Fed clashes with more modest members like Governor Lyle Brainard and San Francisco Fed President Mary Daly.

On top of that, Powell is running for re-election in February, like many other Fed officials, and President Joe Biden has yet to make his priorities known. Powell already knows what it’s like to balk at keeping rates low after his experience with former President Donald Trump, but he has yet to rebuild the Fed consensus somewhat as economic and pandemic conditions change. To keep the herd, cats will have to be tended.

An image of US President Joe Biden is shown on a screen after his address to the nation regarding the situation in Afghanistan as traders work on the floors of the New York Stock Exchange (NYSE) in Manhattan, New York City, United States August 17 We do. , 2021.

Andrew Kelly | Reuters

“The concern for the Fed and the economy is the danger of imposing the political pressure it wants across the political spectrum, and thus undermining the independence of the Fed,” Charles Plosser, former president of the Philadelphia Fed, in a broadcast interview. Est. “.” Powell’s in a tricky place. “

For his part, Powell used his Jackson Hole speech in 2020 to describe a radical policy shift in the way the Fed views inflation. The new framework reflects a desire to achieve full inclusive employment, even if it means warming inflation, and politics has been blamed in some quarters for the price hike this year.

“We are at a time when monetary and fiscal policy is at its most stimulating level that we have seen in 75 years,” Plosser said. “They must ask themselves the question of the role of politics in making this inflation more stable than it would otherwise prove.”

Powell’s Friday speech is unlikely to bring such major breakthroughs in the Fed’s approach, instead focusing on current and future expected conditions, giving little indication of how he and his fellow policymakers will approach it. . I’ll try to manage.

But that will likely set the stage for the central bank to return to normal, so the pressure will always remain.

“The real question for me is what will happen next year,” City quarterback Snyder said. “Have we seen ourselves turning to moderating the economy and controlling inflation, which will make it harder for the Fed to get rates off the ground?”

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