The new chairman of the Federal Reserve may be wondering if the bumpy ride that has marked the first weeks of his tenure will continue throughout his term of office.
Jerome – aka Jay – Powell emerged last November as President Trump’s favoured candidate to succeed Janet Yellen as chief of the Fed, six years after being nominated to its board of governors by Barack Obama.
A former investment banker, Powell took up the post of chairman on February 5, a day that coincided with Wall Street’s sharpest correction since 2011 and a 1,175-point retreat by the Dow Jones.
Not that he will have taken the market’s bout of jitters as casting any aspersions on his abilities to steer the Fed over the coming years. When Powell’s appointment was first confirmed, stocks and bonds headed higher on the common view that he was a “safe pair of hands” and most likely to continue the policy pursued by Yellen.
Taking away the punch bowl
Trump didn’t see fit to renew Yellen’s appointment for a further four-year term but she has stepped down from the Fed with her reputation high.
As the Fed’s ninth and longest-serving chief William McChesney Martin – who served under five different presidents from 1951 to 1970 – observed, the duty of central banks is to “take away the punch bowl just as the party gets started”. Yellen was aware that the zero-to-low interest rate of recent years was the main cause for stock market prices being driven to frothy new heights.
In October 2014 Yellen confirmed that the Fed was ending its $4.5tn bond buying programme launched in the depths of the global financial crisis six years earlier. Just over a year later, in December 2015 the central bank raised interest rates for the first time in nearly a decade.
In a series of “baby steps” over the past two years, rates have been nudged a quarter-point higher on five occasions to their current range of 1.25% to 1.5% and 2018 began with expectations of three similar hikes over the course of the year.
Behind the good news
On the face of it, Powell is stepping up to the plate when the wind is set fair for the US economy. Growth has risen to an annual 3%, the US is near full employment with the jobless rate down to 4.1% and Trump’s tax cuts have boosted corporate profits and workers’ pay.
So what rattled the markets at the start of this month? As business adviser Irwin Stelzer commented: “Almost coincident with a jobs report that showed the economy to be strong and wages rising, the Fed perceptively announced that the economy was strong and wages were rising.”
Hardly revelatory, yet it caused investors to wonder whether the three upcoming rate hikes they’d pencilled-in for this year might turn out to actually be four, even five. At the same time, good jobless data suddenly became a portent of revived inflation that would drive interest rates up even faster and more sharply.
Add to this a further $1tn added to the US national debt from tax cuts, which requires the government to sell more bonds and offer more attractive returns to investors and plans for a further $1.5tn spend to repair America’s crumbling infrastructure.
Applying the brakes
Members of the Federal Open Market Committee next meet on March 20-21, when Powell holds his first press conference as Fed chief, a further quarter point interest rate hike taking the target range to 1.5% to 1.75% is expected and new economic forecasts are released.
A big question is how dovish – or hawkish – his attitude towards inflation is. The Fed’s target rate is 2% and the first month of 2018 saw the US headline rate stronger than expected at 2.1%. This increases the prospects of the brakes being applied to the US economy harder and sooner than previously expected.
At the FOMC’s previous meeting in late January, members were divided in their views on inflation and wage pressures. Some saw “little solid evidence” of either, but others see inflationary pressures rapidly building up.
As John Dizard recently noted in the Financial Times: “A lot of older people and opioid addicts must rejoin the labour force and work efficiently to keep the economy ticking over without an inflationary blowout or a bond market crash.”
Longer-term the duration of Wall Street’s bull run, which began way back in March 2009, suggests that the good times are nearing an end and Powell will have to confront the challenge of another recession in the US sometime over the next four years. It seems likely that the Fed’s traditional response – of cutting interest rates sharply – won’t be available next time around.
Understanding the mechanics
While the consensus is that Powell won’t depart too radically from the policies of his two immediate predecessors, some analysts have latched onto remarks he made in late 2012. The Fed’s low interest rate and money printing initiative to rescue the US economy was then well underway – and Powell cast doubt on its efficiency and expressed concern over the long-term damage that could result.
“The reason he is different from Janet Yellen and Ben Bernanke is that he has worked in markets and he has a grasp of how the markets work and how they function and the relationship between the Fed and markets,” says Quincy Krosby, chief market strategist at Prudential Financial.
“Because he has been with the Fed for a number of years, he understands the balance between the two.”
Also, Loretta Mester, president of Cleveland Federal Reserve is a main contender to become the Fed’s new vice chairman. She’s regarded as one of its more hawkish members and put the case for interest rate hikes when inflation was still subdued.