Powell Exudes Confidence, Hawks Get Louder and Cases Rise
The Federal Reserve Open Market Committee (FOMC) met on Wednesday and elaborated on their decision not to raise rates or adjust the pace of asset purchases. Given the re-emergence of healthcare concerns around the Delta variant, there was much attention on the tone Powell struck with regards to the emerging risk. He exuded confidence on the issue and didn’t think that the Delta would severely derail the timeline to begin reducing the ultra-accommodative posture the central bank has kept since the emergence of the Coronavirus in 2020. Powell also admitted that recent inflation numbers had caught him and his colleagues off guard. However, he stuck to the transitory inflation narrative, as expected.
Powell does have a point. The post-pandemic recovery went better than anyone expected (except for perhaps my colleague Tom Lee) and recent data shows that the US economy has now eclipsed its level of pre-pandemic output. Similarly, to downside panics, the many positives like a strong consumer balance sheet and the lean and mean corporate entities that emerged from a near-apocalypse appear to be creating positive economic momentum that will be hard to stop without the blunt instrument of lockdowns, which we think politicians in heavily vaccinated countries will continue to avoid.
Inflation hawks are indeed being whipped up into a frenzy and the discourse around the issue is probably complicated by the fact that politicos are smelling a juicy political issue that has historically been the bane of incumbents. The fact that inflation hasn’t been as high since Arthur Burns was Fed Chairman, during the Nixon administration, certainly isn’t helping the Doves parry the criticism that the Fed might be behind the curve on inflation. The forces driving this inflation may be more secular than many economists would like to think. Jeremy Bullard called for a rapid taper to begin in the fall and would end only a few months later in the beginning of 2022. This deviates greatly from most board members. The body still tilts towards the doves but that could erode if the longer inflation readings keep coming in significantly higher than forecasts.
Some do argue that the internationalization of the labor market may have been a major deflationary force. Obviously, international trade and commerce has broken down since the pandemic began and this may be alleviating some of the secular deflationary force that the Doves are banking on. However, the only thing that will provide a certain answer is more data and time.
Despite the rising incidence of the Delta Variant, particularly in states with lower rates of vaccination, the world’s most powerful central banker remained decidedly upbeat. “We’ve kind of learned to live with it,” said Powell as he pointed out that each successive wave of the virus since March 2020 has affected the economy less and less. Despite the very real risks of hospitalization and death for the unvaccinated, the economy has performed better than expected in many ways since April 2020.
The inflation numbers keep rising and the hawks and Fed-critics are growing louder and more voluminous. Nonetheless, Powell only gave mere hints of what tapering would look like. It still seems a far way off, and despite Delta not being a major threat to the economic recovery, it is a perfect justification for the Doves to continue extraordinary support to the economy, especially since a lot of the transfers on the fiscal side of the equation that have helped bolster growth will be expiring. While the Fed is supposedly independent, they certainly consider the fiscal side. If you’ll recall a few months ago Jay Powell was actively lobbying for more fiscal support. It has certainly made his job easier.
When referring to the asset purchases, the official FOMC statement said “these asset purchases help foster smooth market functioning and accommodative financial conditions.” One area where this is coming under doubt is in the housing prices where historically high price appreciation casts doubt on the need for continued support. If inflation spikes in the shelter component of the Fed’s preferred reading, this could eventually tip the Fed’s hand and force it to respond to the price readings that have consistently exceeded the agency’s forecasts for multiple months now. We think “two speed taper” will be a term you will hear in the future; meaning that the mortgage purchases will be tapered faster than those of treasuries.
The Fed released its annual 2020 report this week, which is worth a read given that it is one of the most impactful years in the agency’s long and storied history. 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 1.23%.