Powell Gives Additional Coloring on Tapering Schedule and Addresses Evergrande Risk

FS Insight Team

The Federal Open Market Committee meeting took place in the shadow of one of the most vicious market selloffs of 2021 which occurred Monday. While the market sell-off was probably mostly triggered by the insolvency of Evergrande, the Chinese property development giant, the market is also in a seasonally challenging time and is facing a litany of tail risks.

Powell addressed the tapering schedule and if the hawks had an edge, it may have been mitigated by the levels of fear and apprehension in markets in the preceding days. The market largely appeared pleased with Powell’s remarks and despite not announcing a taper, the Fed certainly appears to be taking every possible caution to keep markets sufficiently apprised as to avoid a tantrum.

The tagline of Powell’s conference could probably be surmised in the following quote, “The Fed judges that a moderation in the pace of asset purchases may soon be warranted.” So, consistent with previous messages from the Fed Chair, the committee is sticking with the judgement that even though Delta has wrought havoc from a healthcare perspective, our society has adapted to this reality enough to ensure robust enough economic growth to justify tapering asset purchases is still occurring.

Powell also addressed Evergrande directly. This is a great place to bring up what we have repeatedly called the “Holy Spirit” of the Fed’s “Trinity” of mandates. Did you think they had only two mandates? Well, since the financial crisis the Fed is the primary agency running what is called the Financial Stability Oversight Council. This powerful inter-agency body is tasked with monitoring and attempting to safeguard financial stability. Since the crisis, the Fed has added a lot of data capabilities and tools to help it with this task. The Treasury Office of Financial Research is also crucial to this mission.

So, when Jay Powell says there is not that much exposure to Evergrande in the United States you shouldn’t just assume this is normal soothsaying. He has the data, the staff, and the capabilities to effectively monitor the contagion risk to US institutions. Like credit markets, Jay Powell suggested implicitly that Monday’s sell-off was a dramatic overreaction. Subsequent market action lends credence to his position.

Is the Fed still between a rock and a hard place in some ways? Of course, it is, although leading experts suspect that the communication strategy has been effective in the light of preventing the market from unpleasant surprises. Of course, stability can be a double-edged sword in Fed Policy as Alan Greenspan found out when he raised rates steadily in the run-up to the financial crisis. The “Global Savings Glut” theory postulated that the Fed tried to cool the mortgage market but due to the copious amounts of international capital seeking triple-A rated high-yield, the typical mechanism was ineffective.

Many worry the Fed may be in a similar situation if inflation proves doggedly persistent. One thing is for sure, FOMC leadership as specifically indicated by Powell’s Jackson Hole speech seem more comfortable with the risk of committing rapid and large-sweeping actions to stave off runaway inflation then they are of tackling a potential deflation spiral. At least, the bazooka of the world’s leading central bank is more effective in the former situation.

The other big news from this Fed meeting was that there were hawkish developments in the Summary of Economic Projections. The consensus of anonymous projections suggests that the anticipated, and maybe dreaded, rate liftoff was now likelier to occur in 2022 as opposed to 2023. For what its worth, Jay Powell says to take the “dot plot” with a heavy dose of salt.

Asset purchases continued at a pace of $40 billion a month for MBS and $80 billion a month for Treasuries. The benchmark yield on the 10 year is 1.45%. This was a more than 10 bps move from last week.

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