Standing behind a podium at its Washington headquarters, Federal Reserve Chairman Jerome “Jay” Powell delivered a stark message to the global investment community: The Fed is about to tighten the money supply, even if it means to hurt.
The Fed had previously kept interest rates extremely low and pumped trillions of dollars into the banking system through extraordinary measures known as “quantitative easing.” But to keep the economy growing and inflation low, now is the time to remove that stimulus. That process, Powell declared, would be on “autopilot” — not slowed down or hindered by stock price crashes or bond market panics. The Fed was set up to do such a difficult job without political pressure, and Powell is determined to get it done. Taking a more hawkish stance was “always a good option and I don’t think we need to change that,” he said.
That scenario could play out any number of times in 2022, as Powell and the Fed begin to ramp up efforts to tackle unprecedented increases in consumer prices. But he said that on Dec. 19, 2018, less than a year after Powell had been Fed chairman. Washington and Wall Street are increasingly concerned about how the central bank’s actions will disrupt the economy after nearly a decade of “quantitative easing” to offset the effects of the Great Recession.
In this way, Powell became a financial disciplinary committee, and the market objected to it. The synchronized decline in stock, bond and commodity prices has been frightening, shocking analysts who had thought it unthinkable. In just three weeks, the S&P 500 has entered correction territory, down nearly 16%. In typically thin trading on Christmas Eve, the Dow Jones Industrial Average fell 3%. Even President Trump, who nominated Powell to head the Fed a year ago, accused Powell on Twitter of relying on “meaningless numbers” in an attempt to urge him to stop tightening policy.
Powell had expected this. He predicted such a mess when he entered the Fed, even though at the time he only suggested an end to quantitative easing. The Fed’s easy money policy has pushed up asset prices, and countermeasures will pay off.
Yet when such a price came, Powell and the Fed backed down. Within weeks, Powell dropped plans to tighten monetary policy. “The case for higher rates has weakened somewhat,” he said at a news conference in January 2019. Markets rallied, with stocks and bonds rallying in tandem, as they had previously fallen in tandem. What about autonomous driving? Lifted.
Wall Street refers to this past event as the “Powell turn.” That suggests that Jay Powell, once seen as an outlier at the Fed, may continue a tradition that began with Alan Greenspan’s presidency in the 1980s and 1990s. If markets go awry, the Fed will step up to protect investors, even at the risk of problems like inflation worsening later.
The key to understanding the current risks of dealing with the worst inflation in the US since the early 1980s, and the turmoil in equity and bond markets during that time, is understanding the “Powell turn.” Powell has promised again that the Fed will tighten monetary policy. But a host of stakeholders, including investors, bankers and members of Congress, are betting Powell will pivot again.
“I think a lot of people think Powell isn’t telling the truth, because he’s always been,” said Rick Scott, a Florida Republican. Met a few times to get a sense of how aggressively Powell will tighten policy. Scott is still undecided (Powell declined to be interviewed for this article).
Similar uncertain scenes are played out in the market every day. Stocks and bonds fall sharply after alarming inflation data, which signals that the Fed will continue to raise interest rates, and rise when economic activity slumps, because it may persuade the Fed not to raise interest rates . It’s not uncommon for stock indexes to gain and lose two percent on the same day. The CBOE Volatility Index (VIX), a key gauge tracking the magnitude of market volatility, started rising in late 2021 and has remained high since then. Markets and economies in Europe and Asia were also volatile as rising U.S. interest rates could depreciate other currencies.
Over the past few decades, investors may have looked to the Federal Reserve as a pinnacle of stability. It is the most powerful institution in finance, and the Ph.D. The money supply, again loosens policy when the economy needs momentum. But those days are over thanks to the Fed’s unprecedented sweeping intervention in the economy over the past decade. Years of zero interest rates, combined with a dramatic increase in money printing, have fundamentally reshaped the financial landscape. It has also transformed the image of the head of the Federal Reserve from that of omniscient engineers into a group of darkroom explorers.
One way to gauge the size of this change, and the strides the Fed has left in the economy, is to look at the size of the Fed’s balance sheet, because the Fed’s balance sheet grows when it prints money. From 2008 to 2014, under the quantitative easing policy, the balance sheet of the Federal Reserve increased from 900 billion US dollars to 4.4 trillion US dollars. And this is just the beginning. Jay Powell led the largest economic intervention in history in the wake of the COVID-19 pandemic, nearly doubling the size of the Fed’s balance sheet to nearly $9 trillion, where it remains. This policy has far-reaching implications. All the money the Fed issues goes out through purchases of US Treasuries (see below for details). By the middle of this year, the Fed held 25% of the total outstanding balance of U.S. Treasuries.
When an institution takes such big strides, every step it takes can cause earthquakes — as the Fed has demonstrated in 2022. Under the leadership of Powell, the Fed will raise interest rates six times from March to November 2022, raising the U.S. short-term benchmark interest rate from 0.25% to 4%, and it is possible to raise interest rates for the seventh time in December. Powell also paused quantitative easing. At the same time, the stock market fell. The cost of debt in the United States has risen significantly. Corporate borrowers are at risk. No one really knows how bad things are going to go.
Powell’s background before becoming Fed chairman makes his next move difficult to predict. He is the first non-economist to head the Fed in decades. In his previous career, he has been running between big government and big money on Wall Street. Lawyer-trained and a former private-equity dealmaker, he worked at the respected Carlyle Group from 1997-2005, where he led a particularly lucrative takeover of an established industrial conglomerate Group Rexnord. Powell is a true product of American capital, born in a wealthy suburb of Washington, and has always worked around the rich and powerful.
However, Powell also has the qualities of everyman. He is self-deprecating, and his humility seems unlikely to be insincere. He was known to bike to work at the Federal Reserve for the purpose of exercising. He speaks thoughtfully, constructing his arguments the way a chip factory worker solders a circuit board.
“He’s definitely good at thinking,” said Betsy Duke, a close working partner of Powell’s since joining the Fed in 2012 and a former Fed governor. Duke and Powell also come from private financial institutions. Duke was always impressed by Powell’s way of thinking like an investor looking at complex data. According to Duke’s recollection, when introducing the American old-age medical insurance, Powell deeply explored the root of this problem, and compared the per capita medical expenses with medical outcomes. The results showed that the figure in the United States was much higher than that in other countries. Powell pointed out that by closing this gap, the cost problem of Medicare for the elderly in the United States will basically disappear. “He was able to connect issues that weren’t obvious when you normally read the data,” Duke said.
But that flexibility only makes Powell’s approach to inflation more mysterious. He has shifted positions on major monetary policy issues before, and he has called such changes his leadership characteristics. Powell insisted it was not a political decision. It is simply a pragmatist’s response to changing circumstances. Powell once said to me in 2020: “My opinion changes with the evidence.”
Current and former colleagues describe this as one of Powell’s strengths. But on Wall Street and in Washington, no one is sure which direction Powell will go, which is to say, they can find hope or fear in each of Powell’s statements.
When he became a Fed governor in 2012, Powell was something of a dissident. Almost immediately, he became concerned about the Fed’s core policies and the way it behaved aggressively.
Then-Chairman Ben Bernanke was arguably the most interventionist Fed leader in history. The Fed can’t build dams, educate students, or put shovels into other people’s hands. All it can do is print money. After the global financial crisis, Bernanke took this function to an unprecedented level. First, he pushed the Federal Open Market Committee to keep short-term interest rates at zero. Short-term U.S. interest rates have only briefly touched zero before, and this time the Fed kept rates at zero from 2008 until the end of 2015. At the same time, it was Bernanke who launched the far-reaching and radical quantitative easing experiment.
Quantitative easing is essentially a means of providing capital to banks, which gives them more money to lend or invest, thereby fueling economic growth. To do this, the Fed would contact a large bank, such as Wells Fargo, and offer to buy $10 billion of U.S. Treasury bonds. When Wells Fargo sold these treasury bonds to the Federal Reserve, the Fed only needed to issue more money to buy treasury bonds. The money would appear immediately in Wells Fargo’s reserve account with the Fed. The Fed has been doing such deals for the past 15 years, printing trillions of dollars of additional money.
The key problem is that the Fed has been setting short-term interest rates at zero while printing these currencies. This strategy, of funneling money into Wall Street while undermining the ability to earn interest on savings, has created a powerful force known as “yield chasing.” With interest rates so low, large investors such as insurance companies or pension funds must frantically seek higher returns from riskier investments. That in turn pushed up stock and bond prices, as trillions of dollars of new money were all chasing the same assets.
This policy has significantly widened the gap between rich and poor. The richest 1% of Americans own nearly 30% of U.S. assets, up from about 18% two decades ago, while the bottom 50% of Americans own about 5%, according to Fed data. With wealthier individuals holding a larger share of their net worth in stocks and bonds, quantitative easing helps explain the extraordinary wealth growth of the wealthiest group in the 2000s, even as incomes stagnated for most wage earners case. Meanwhile, Wall Street has come to understand the Fed more and more, and a few “balance tantrums,” or asset price crashes as the Fed embarked on scaling back quantitative easing, have helped convince many observers that if the Fed took the Big bowl, a huge disaster is about to come.
When he first entered the Fed, Powell had pointed out that quantitative easing was on the verge of getting out of control. “We need to regain control of it,” he said at a FOMC meeting in 2013. At another meeting, he warned that quantitative easing had raised asset prices to the point where it could suddenly trigger disaster. In his view, the Fed is piling up long-term risks that could lead to runaway inflation and future asset price crashes for very little short-term gain. The way Powell made his point was vivid. He’s not the type to slap tables or make extreme statements, instead he backs up his analysis with exhaustive detail. To illustrate his point in a debate in 2013, Powell pointed to a survey of 75 investment managers, 84 percent of whom believed the Fed was raising asset prices, including junk-rated corporate bonds. In another meeting, Powell described the market’s steep decline in economics terms, saying: “The eventual pullback could be deep and strong.”
Needless to say, Bernanke will not be happy to hear that. Quantitative easing was Bernanke’s invention and could end up being a big part of his legacy. As time went on, Powell’s doubts gradually diminished. In 2015, he even praised quantitative easing in a speech. To the question of why there was a change, Powell responded that there was new data supporting quantitative easing. But a colleague and friend of Powell’s, former Dallas Fed president Richard Fisher, told me in a 2020 interview that he was skeptical of Powell’s claims. It’s more likely, Fisher said, that Powell is following the prevailing opinion within the Fed’s leadership circle: “It’s probably a change from being there longer and being surrounded by great colleagues who are very academic. You Being in a closed atmosphere . . . becomes more submissive.”
When Powell was promoted to chair in early 2018, the Fed was trying to tighten monetary policy, in part because U.S. economic growth was finally returning to near-normal levels and unemployment was low. By mid-2018, the Fed had raised interest rates from zero to about 2.5%. But later that year, when Powell signaled a reduction in quantitative easing, markets were thrown into turmoil and the president fired up. It was the “Powell turn” that calmed the trouble.
Of course, the Fed has pumped trillions of dollars into the market again during the corona crisis while keeping interest rates at zero. Even in mid-2021, the need to tighten monetary policy or bring it back to normal seems a distant question. Next, in the case of expanding price increases, Powell first showed no concern, calling it “temporary” inflation. But a misjudgment of the situation has him now in trouble. Contrary to what Powell said, the U.S. economy has deep, broad-based inflation that is starting to heat up. In June 2022, the inflation rate in the United States will reach 9.1%.
The Fed’s core mission is to eliminate inflation, and its only means is to tighten policy, and Powell has firmly stated that he will do so. At the Jackson Hole annual meeting in Wyoming in August 2022, the Fed exited its easy money policy. The Fed has raised rates four times in the past five months. Powell’s speech at the annual meeting bluntly sent a sobering and shocking signal-the Fed will raise interest rates and keep interest rates high until the inflation rate falls back to the 2% target level. If it hurts the economy, so be it. “That’s the unfortunate price of lowering inflation, but the price of not being able to restore price stability could be far greater,” Powell said.
Powell is still under pressure to turn again, both implicitly and explicitly. Senator Elizabeth Warren, D-Massachusetts, sent a letter to Powell this Halloween, and her office made the letter public shortly thereafter. Warren wants Powell to explain exactly how many jobs the Fed’s rate hikes might put out of work and how wages might be affected. She quoted Powell himself as saying the Fed should tighten policy even if it would cause a recession. “These words clearly fail to take into account the livelihoods of millions of American wage earners, and we are deeply concerned that your rate hikes could slow economic growth while failing to curb price increases that continue to hurt families,” Warren wrote in the letter. The letter was co-signed by ten other progressive senators.
Warren’s letter appears to suggest that Powell has a lot of latitude. In effect, Powell appears to be walking on a narrow causeway, and the circumstances at either end are unattractive. He can tolerate high inflation, but at the risk of it building up and starting to spin out of control. He could also tighten the money supply, but doing so risks a recession and a possible financial crisis.
Left unchecked, inflation could enter a self-contained spiral, causing prices to rise much faster than wages, hurting working and low-income families. At the same time, investors are also under threat from all the riskier trades made during the massive “yield hunt,” many of which used borrowing, while short-term interest rates controlled by the Fed have been at 4% or higher. levels, rather than close to zero, the value of these transactions would have to be revalued.
Interest-rate-sensitive parts of the economy have already taken a hit, with the housing market starting to slow as mortgage rates rose to their highest in decades. Highly indebted companies struggled as higher interest rates boosted their interest payments. From January to September 2022, the value of the S&P 500 has evaporated by nearly 25%. Long-term high interest rates will almost certainly leave millions of Americans jobless, with unpredictable consequences.
With the impact of austerity already so severe, many investors seem convinced that Powell will eventually soften his tone. They believe a Fed under Powell will not cause a financial crisis or a devastating recession, even if it has to deal with inflation. In October 2022, the U.S. inflation rate was 7.7%, which was lower than expected but still at a very unfavorable high point. As soon as the news came out, the Dow rose another 1,200 points. It can be said that some of the dovish voices come from within the Fed. Ahead of the November FOMC meeting, Chicago Fed President Charles Evans said the Fed was raising rates so fast that there might be “a situation where policy can be planned to stop. “. Fed Vice Chairman Lael Brainard echoed Evans in another statement.
However, the Fed raised rates again at its November meeting. In subsequent news conferences, Powell managed to cool down any thoughts he might have turned. “What I want to do is make sure our message is clear that we think we have a long way to go,” Powell said. How long is “a long way”? As far as Powell’s personal idiosyncrasies go, he probably won’t know until after he’s gone. At the same time, investors with more and more motion sickness can only sit in the back seat and ask: “Is it not there yet?” (Fortune Chinese website)
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