Oh the games that the Fed plays!
Abraham George Macro Musings
The most anticipated speech from Jerome Powell this year happened last Friday. Before we get into that, let’s discuss a bit about Powell’s background.
Firstly, Powell is not a seasoned central banker. He is from the industry while all other Fed chairmen have been from the academia. Powell heads an army of PhDs at the Fed (more than 1000 or so), while he himself is not a PhD. When he took position as the Fed Chairman, he had very idealistic views about the economy and central banking which he had to soon abandon and become more pragmatic. The early years were very tough for him as he contradicted many statements that he made publicly and back tracked on many of the policies that he had in mind.
President Trump was mostly critical of him and openly stated many times that it was his biggest mistake that he appointed Powell as the Fed chairman. Powell never criticized the president publicly or through the media. As Fed watchers evaluate him now, he has learned the art of managing the media and manipulating the expectations consumers and businesses as part of the Fed’s policy making.
The Fed’s biggest job is to foster stability in the markets and nudge the economy and the interest rates on the Fed’s preferred trajectory. For the most part, it works - we have had fairly good management from the Fed but when it fails, they become fire fighters. It is the level of confidence and commitment that they communicate into the economy that matters the most - even more than their actions on monetary policy and fiscal policy.
Actually in Mar 2020, when the treasury market was getting messier and the confusion spawned a lot economic uncertainty, the Fed was able to backstop the troubled corporate bond market by buying only $14 bio of corporate bonds, a very small amount compared to the total market.
It was the threat, that they would do ‘whatever it takes’ that returned stability, not just to the corporate bond market, but to the treasury market and by extension - to the global markets at large (i.e. stocks, bonds, commodities - everything that was tradeable).
So, the Fed Chairman’s speech on last Friday was a healthy dose of expectation manipulation. Before Powell could speak, the Fed rolled out Fed president after Fed president for interviews with the financial media. Their job was to convince the markets that the Fed sees the economy in good shape, inflation as possibly a higher risk than previously projected, and it was time to start winding down the QE program.
So what did their chief do? He took it all in. He gave us five reasons that inflation is not really a big threat. Powell still argues that inflation is transitory or temporary. He is not worried about the absolute level of inflation. But the rate of change of inflation in relation to the size of the economy. He emphasized that there are isolated cases of inflation but his focus is on the overall level of inflation. He is concerned about wage inflation. As too much of that can create runaway inflation.
As new money enters the market, which is coming down the pike with trillions of planned stimulus, asset prices will continue to rise, followed by goods and consumer items. Eventually, wages should rise as well. Powell also mentioned about the lag in policy as any aggressive policy now will look like that it was not required in nine months or in an years time. Therefore, Powell’s statement have been very dovish. He has poured water on the fire that his subordinates were talking up and kindling.
There shouldn’t be any policy action in Sep or Nov. So far things, are moving in Powell’s way. They want to remove accommodation at their schedule. They just don’t want to see a run up in interest rates which is not happening now. In fact, interest rates finished lower. Stocks markets took off and so did all other asset classes.
So let us wait and watch how this plays out eventually. All I know is that historically the Fed has been consistently wrong on inflation projections!
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.