Apparently, Powell has learned
Why everyone’s been so concerned
With prices exploding
The sense of foreboding
‘Bout ‘flation seemed very well earned
So, Jay and his friends at the Fed
Said by March, that they would stop dead
The buying of bonds
Til ‘flation responds
(Or til stocks fall deep in the red)
By now you are all aware that the FOMC will be reducing QE twice as rapidly as their earlier pace, meaning that by March 2022, QE should have ended. Chairman Powell was clear that inflation has not only been more persistent than they had reason to believe last year but has also moved much higher than they thought possible, and so they are now forced to respond. Interestingly, when asked during the press conference why they will take even as long as they are to taper policy rather than simply stop buying more assets now if that is the appropriate policy, Powell let slip what I, and many others, have been saying all along; by reducing QE gradually, it will have a lesser impact on markets. In other words, the Fed is more concerned with Wall Street (i.e. the stock market) than it is with Main Street. Arguably, despite a more hawkish dot plot than had been anticipated, with the median expectation of 3 rate hikes in 2022 and 3 more in 2023, the stock market rallied sharply in the wake of the press conference. If one is seeking an explanation, I would offer that Chairman Powell has just confirmed that the Fed put remains alive and well and is likely struck far closer to the market than had previously been imagined, maybe just 10% away.
One other thing of note was that Powell referred to the speed with which this economic cycle has been unfolding, much more rapidly than the post-GFC cycle, and also hinted that the Fed would consider reducing the size of its balance sheet as well going forward. Recall, however, what happened last time, when the Fed was both raising the Fed funds rate and allowing the balance sheet to run off by $50 billion/month back in 2018; stocks fell 20% in Q4 and the Powell Pivot was born. FWIW my sense is that the Fed will not be able to raise rates as much as the dot plot forecasts. Rather, the terminal rate will be, at most, 2.00% (last time it was 2.50%), and that any shrinkage of the balance sheet will be minimal. The last decade of monetary policy has permanently changed the role of central banks and defined their behavior in a new manner. While not described as such by those “independent” central banks, debt monetization (buying government bonds) is now a critical role required to keep most economies functioning as debt/GDP ratios continue to climb. In other words, MMT is the reality and it will require a much more dramatic, and long-lasting, negative shock for that to change.
One last thing on this; the bond market has heard what Powell said and immediately rallied. The charitable explanation is that bond investors are now comforted by the Fed’s recognition that inflation is a problem and will be addressed. Powell’s explanation about foreign demand seems unlikely, at least according to the statistics showing foreign net sales of bonds. Of more concern would be the explanation that bond investors are concerned about a policy mistake here, where the Fed is tightening too late and will drive the economy into a recession, as they always have done when they tighten policy.
With Jay and the Fed finally past
The market will get to contrast
The Fed’s hawkish sounds
With Europe’s shutdowns
And watch Christine hold rates steadfast
But beyond the Fed, this has been central bank policy week with so many other central bank decisions today. Last night the Philippines left policy on hold at 1.50%, as did Indonesia at 3.50%, both as expected. Then, this morning the Swiss National Bank (-0.75%) left rates on hold and explained the franc remains “highly valued”. Hungary raised their Deposit rate by 0.30% as expected and Norges Bank raised by 0.25%, also as expected, while promising another 0.25% in March. Taiwan left rates unchanged at 1.125%, as expected and Turkey continue their unique inflation fighting policy by cutting the one-week repo rate by 1.00%, down to 14.00% although did indicate they may be done cutting for now. As to the Turkish lira, if you were wondering, it has fallen another 3.8% as I type and is now well through 15.00 to the dollar. YTD, TRY has fallen more than 51% vs. the dollar and quite frankly, given the more hawkish turn at the Fed, seems like it has further to go!
Which of course, brings us to the final two meetings today, the ECB and the BOE. Madame Lagarde and most of her minions have been very clear that they are not about to change policy, meaning they will continue both the PEPP and APP and are right now simply considering how they are going to manage policy once the PEPP expires in March. That is another way of saying they are trying to figure out how to continue to buy as many bonds as they are now, while losing one of their programs. I’m not worried about them finding a way to continue QE ad infinitum, but the form that takes is the question at hand. While European inflation pressures have certainly lagged those in the US, they are still well above their 2.0% target, and currently show no signs of abating. If anything, the fact that electricity prices on the continent continue to skyrocket, I would expect overall prices to only go higher. But Madame Lagarde is all-in on MMT and will drag the few monetary hawks in the Eurozone down with her. Do not be surprised if the ECB sounds dovish today and the euro suffers accordingly.
As to the BOE, that is much tougher to discern as inflation pressures there are far more prevalent and members of the MPC have been more vocal with respect to discussing how they need to respond by beginning to raise the base rate. But with the UK flipping out over the omicron variant and set to
cancel Christmas impose more lockdowns, it is not clear the BOE will feel comfortable starting their tightening cycle into slower economic activity. Ahead of the meeting, the futures market is pricing in just a 25% probability of a 0.15% rate hike. My money is on nothing happening, but we shall see shortly.
Oh yeah, tonight we hear from the BOJ, but that is so anticlimactic it is remarkable. There will be no policy shifts there and the yen will remain hostage to everything else that is ongoing. Quite frankly, given the yen has been sliding lately, I expect Kuroda-san must be quite happy with the way things are.
And that’s really the story today. Powell managed to pull off a hawkish turn and get markets to embrace risk, truly an impressive feat. However, over time, I expect that equity markets will decide that tighter monetary policy, especially if central bank balance sheets begin to shrink, is not really a benefit and will start to buckle. But right now, all screens are green and FOMO is the dominant driver.
In the near term, I think the dollar has further to run higher, but over time, especially when equity markets reverse course, I expect the dollar will fall victim to the impossible trilemma, where the Fed can only prop up stocks and bonds simultaneously, while the dollar’s decline will be the outlet valve required for the economy. But that is many months away. For now, buy dollars and buy stocks, I guess.
Good luck and stay safe