Lost In Translation

“S&P Futures Fall; Powell Spoke on NPR.”

That was the headline on one of Bloomberg’s quick summary alerts summarizing potential key trading levels for the S&P Thursday, but it could just as easily be a headline from any other day when markets are open and the Fed isn’t in a pre-FOMC blackout.

Just substitute whatever stocks are doing for “Fall” and wherever Powell is speaking for “NPR” and you’ll have a headline with at least some claim on being accurate. For example, “S&P futures rise; Powell spoke to business leaders.” Or, “S&P futures flat; Powell to speak on Capitol Hill.”

If it’s occurred to you recently that the Fed may be too far down the rabbit hole to climb out, you wouldn’t be wrong. Even as policymakers promise to keep rates glued to the lower bound and give advanced notice not just of any actual tapering plans, but in fact of any plans to even have a substantive discussion about a future tapering, there’s a material risk that the market ends up forcing the Fed into WAM extension and, ultimately, yield-curve control.

What I wanted to briefly point out is that this doesn’t necessarily have to be some arcane discussion that only STIR traders are capable of carrying on coherently. There a number of channels through which markets can force the Fed to ease or double- and triple-down on existing commitments to accommodation.

Recall that in 2018, Powell’s “stick to it” approach to incrementally tighter policy conspired with idiosyncratic drama in emerging markets, including and especially Argentina and Turkey. Eventually, it became difficult to distinguish chicken from egg. Turkey is now back in crisis (although things appeared to stabilize mid-week), Brazil’s a mess and it’s not a stretch to say that China’s tech crackdown could be a serious drag on EM equities.

The MSCI EM gauge erased its YTD gains on Thursday, for example.

The gauge is now in a correction, down around 11% from a record-high hit midway through last month.

Powell is likely to be more careful in 2021 than he was in 2018 about leaving developing nations to fend for themselves as the US plows ahead with fiscal stimulus (in 2018 it was supply-side, now it’s demand-oriented), especially considering humanitarian concerns around the pandemic and equitable vaccine distribution.

But if US yields rise, and the dollar strengthens on economic outperformance and less negative real rates (hence the scare quotes around “up” in the figure below), developing nation assets will be vulnerable despite the fact that Powell’s policy bent is the polar opposite of what it was this time three years back.

Obviously, financial conditions are still extremely easy, but there’s a very real sense in which the further down the rabbit hole you go, the more fragile things get, and the lower the threshold for triggering cross-asset tumult.

In 2018, Powell learned that ~1% on US real yields was the ceiling. Anything higher than that and it all falls apart. Fast forward to 2021 and who knows where that ceiling is, but one thing seems certain: It’s lower than 1% and may well be negative. That is: It could be that the world can no longer cope with positive 10-year real yields in the US.

More vexing, the Fed may eventually find itself on the wrong end of accusations that its policies are stoking higher food prices globally.

That’s not a new criticism (see here), but it adds to an already vexing situation: More accommodation to alleviate upward pressure on US yields and snuff out any nascent rebound in the dollar could inadvertently precipitate higher commodity prices, worsening the situation shown in the figure (below).

Higher food prices in developing and frontier economies can trigger social unrest.

Coming full circle, you might ask what, exactly, Powell said to NPR this morning that made headlines?

Well, when you read the actual transcript, you discover that the verbatim quote was quite dovish. To wit:

So we will very, very gradually over time and with great transparency, when the economy has all but fully recovered, we will be, you know, pulling back the support that we provided during emergency times.

Unfortunately, Bloomberg translated that into the following red hed: POWELL: WHEN ECONOMY HAS FULLY RECOVERED WE’LL ROLL BACK AID

You can see where the problem might have come in.