US Fed Chairman Jerome Powell Could Blow Up Markets This Week

While the Fed could shift to smaller increments than its recent 75 basis point hike streak, Powell and his colleagues would be well aware that it would be better to risk an actual recession than to allow elevated inflation rates and inflation expectations to rise. they take root

Powell himself would also be aware of his gross misreading of the US economy at the same event in the Grand Tetons a year ago, when he upheld the Fed’s stance that a rise in inflation to highs of 30 years was transitory. It has since climbed to 40-year highs.

The thesis of his speech last year was that the rise in inflation was the product of a relatively small group of goods that had been directly affected by the pandemic and the reopening of the US economy and that, due to the long experience of the Fed , the inflationary effects will be transient and disappear over time.

He expected a reversal to the pre-pandemic setting of stubbornly low inflation, driven by disinflationary forces including technology, globalization and demographics.

“While the underlying disinflationary factors are likely to evolve over time, there is little reason to think that they have suddenly reversed or subsided. It seems more likely that they will continue to weigh on inflation as the pandemic becomes history,” he said.

Charging

Powell’s assumption that economies could simply return to pre-pandemic norms, even over time, has been severely challenged by events.

Supply chains, while improving recently, still do not function as they did before the pandemic and, in some cases, have been permanently reshaped by the painful self-sufficiency lessons experienced during the pandemic.

China’s economy continues to sputter and disrupt global product supply due to its harsh approach to COVID and, in any case, is not the hub of low-cost production and the force for global deflation that it once was. The heightened tensions between China and the US and its allies will also not be transitory and will reshape the post-pandemic economic order.

The Russian invasion of Ukraine will have lasting impacts on energy and agriculture supplies, prices and supply chains.

The pandemic has affected attitudes towards work, impacted migration and produced historically low unemployment rates and labor shortages in developed economies.

Powell’s Jackson Hole speech is his best opportunity to clarify Fed policies and expectations and lower expectations that rate cuts are on the Fed’s 2023 horizon.

Whatever the post-pandemic norm looks like, once it finally emerges, it is likely to be quite different from the pre-pandemic period that Powell described now that he and his colleagues have belatedly recognized that the high rates of inflation that now experienced throughout the world are something that is not transient.

Powell will need to address the disconnect between what markets are factoring in and what the Fed is likely to do before investor optimism takes hold and undermines the central bank’s efforts to tighten financial conditions.

The recovery of the stock market and the shape of the US yield curve, which is inverted (long-term bond yields are below those of shorter-term securities) are making it easier and cheaper to companies to raise equity and debt and sending a message to the general public. population that loans will be cheaper next year.

Powell needs to erase any doubt about the Fed’s commitment to bring the US inflation rate down to its target, regardless of the economic damage in the process, because the risk of not doing so is even greater damage in the future.

Doing so could trigger a sell-off in stocks and bonds and reignite volatility in what have become complacent markets as this year progresses, but the Fed may find it necessary if participants in the financial system are to be convinced to that this time, it will maintain its value.

Ultimately, you need investors to focus not on where and when interest rates will peak, but how long they will stay there. In developed economies, post-pandemic borrowing is at levels that mean rates won’t necessarily have to rise to record highs to flatten activity and the rate of inflation.

To achieve the lasting results sought by the Fed and its peers elsewhere, duration – and expectations that rates will stay high longer – may be more important than scale, particularly as the Fed and other central banks have a second weapon to control inflation. armories

Charging

The Fed will double the amount of bonds and mortgages it owns next month and allow them to mature without reinvestment.

That’s $95 billion ($138 billion) of QA a month, or about $2.2 trillion over the next two years, and is roughly equivalent to several additional 25 basis point rate hikes. Along with conventional rate hikes, the withdrawal of liquidity will tighten credit conditions.

Powell’s Jackson Hole speech is his best opportunity to clarify Fed policies and expectations and lower expectations that rate cuts are on the Fed’s 2023 horizon.

If you do what you need to do and make it clear that the Fed will do whatever it takes to control US inflation, the markets won’t like it, but gaining control over the inflation narratives and rates would make it easier for the Fed gain control of inflation – and bring forward the time when the cycle of rising rates ends and eventually changes.

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