Jay Powell: Unlikely ‘Victim’

SocGen’s Albert Edwards doubts the Fed will ever be able to normalize policy.

I doubt it too. I spent most of last weekend emphasizing as much (here and here, for example).

In a note dated Thursday, Edwards wrote that the reaction to the June FOMC (characterized by an abrupt reversal of reflation trades, especially steepeners), “demonstrates the market’s sensitivity to the Fed’s intentions.”

He flagged last week’s long-end rally, on the way to asking whether the bond market “now realizes that a Fed tightening cycle is nigh on impossible?” I’d note (again) that the fireworks in the curve were the result of a generalized washout, which seemed to create a kind of false “growth scare” optic, where bonds appeared to be “saying” that the Fed was preemptively undermining its own determination to engineer an economic overheat.

When it comes to the Fed being “slaves to the bubbles that they blow,” as Albert put it Thursday, it’s perfectly legitimate to assign blame. And yet, I think it’s important to take a step back.

Continuing along the post-GFC trajectory wherein monetary policy acts mostly alone (i.e., without a concurrent fiscal impulse) will invariably lead to more of the same when it comes to sub-optimal societal outcomes (like extreme inequality), speculative excess and rampant mispricings. But there are consequences when one deliberately bursts a bubble in the interest of preempting a larger bust later.

Society is becoming more unequal all the time, and a controlled demolition of the stock market would disproportionately affect the wealthy the same way a rising stock market disproportionately benefits the rich. But what have you really accomplished if you purposefully trigger, say, a 50% decline in the S&P? I suppose you could technically close the wealth gap that way, but is it not obvious that someone who came into such a wipeout worth $50 million will come out infinitely better than a household who came into it with savings of $50,000, even if the latter owned no stocks at all? Although not all burst financial bubbles have knock-on effects for Main Street, many do. And a $50,000 cushion may as well be zero in a deep recession for a family with children and a mortgage payment. If a member of that household were to lose a job or get seriously ill, it would be an economic death knell. The multi-millionaire would face no such peril, even if half her on-paper net worth evaporated overnight.

Edwards chided Jerome Powell on Thursday for his (Powell’s) contention that the Fed will taper when its macro goals are achieved. “Is this the same Jerome Powell who, at the end of 2018, after talking tough for months about the unwinding of the Fed balance sheet being on ‘auto-pilot’ did a 180 degree about turn when markets began to swoon at the end of that year?,” Albert asked, joking that Powell “is indeed nimble – in retreat!”

The figure (below) illustrates his point.

Make no mistake: It is funny. And I’ve certainly had my share of laughs at Powell’s expense as it relates to that episode.

But remember, that didn’t exactly happen in a vacuum. For one thing, the US and China were locked in an increasingly bitter trade war.

In addition, Donald Trump was publicly deriding the Fed on a fairly regular basis and there were rumors that he (Trump) had asked advisors whether he could remove Powell. The public derision (and the rumors) mattered for market sentiment. And they mattered a lot.

For example, during 2018’s shortened Christmas Eve session, Trump famously likened Powell to a golfer who can’t putt. That tweet exacerbated an already perilous situation for stocks, which were in the process of logging their worst December since the Great Depression. The rout would have been even deeper had it not been for late-month rebalancing flows.

At the same time, Trump forced a government shutdown (over his border wall), further undermining sentiment.

When reflecting on December of 2018 (and Powell’s pivot on January 4, 2019, during an event with Janet Yellen and Ben Bernanke) one has to consider the context. The circumstances were exigent to say the least, and there’s a very strong argument (indeed, it’s more “statement of fact” than it is “argument”) that had Trump and other high-profile figures not spent so much time telling the public how dangerous the Fed’s balance sheet runoff purportedly was, Powell wouldn’t have been compelled to pivot so dramatically.

Think about who else was pressuring Powell to cease and desist from tightening at the time. It wasn’t just Trump.

For example, a Wall Street Journal Op-Ed published on December 16, 2018, declared: “Fed Tightening? Not Now. The central bank should pause its double-barreled blitz of higher interest rates and tighter liquidity.”

“Double-barreled blitz.” “Tighter liquidity.” Strong words for a policy rate that was still laughably low by historical standards and a balance sheet that would be unrecognizable to some Rip Van Winkle who’d just woken up from a two-decade nap.

What kind of know-nothing, ne’er-do-well would use such bombastic terms to implore the Fed to stop tightening policy well before it was anywhere near “normal”?  Well, that Op-Ed in the Journal was penned by the cartoonish Stephen Moore — Oh, wait! No it wasn’t. It was penned by none other than Stan Druckenmiller and Kevin Warsh.

The point is, Powell, who isn’t an economist, inherited a tightening cycle and was tasked with completing it under a Donald Trump presidency. That’s an impossible task. And dammit, he tried anyway (figure below), pushing real yields to 1.15%, a level that may as well be Mount Everest looking up from where we are today, trawling around under water, on the ocean floor.

Barely a year on from his famous “pivot” (first figure above) Powell was blindsided with the worst public health crisis in a century, which triggered a fleeting depression — with a “d.”

If you count the Q4 2018 episode (which you probably should), Powell has seen two bear markets in less than four years.

So, if asked to assess the veracity of Edwards’s claim that (and I’m quoting him directly here) “the Fed’s ambition to normalize rates can never be achieved,” I’d say that statement is about as close to 100% accurate as one can get in a world where nothing is truly certain.

But let’s face it: This isn’t Powell’s fault.

Sure, he spent years along for the policymaking ride and transcripts of FOMC meetings reveal he was acutely aware that the decision-making body of which he was a part was knowingly engaged in activities conducive to fostering dangerous speculative excess across every asset known to man.

That makes him complicit, but it doesn’t make him culpable, not when he was surrounded by a group of Ivory Tower economists with delusions of grandeur, all hell-bent on the notion that they can eliminate the business cycle altogether if they just do enough “tweaking.”

Powell is, by now, a victim of circumstance.

Well, as much as an accomplished lawyer and banker worth tens of millions of dollars can be a “victim,” that is.

“You may know this — there’s a pretty substantial tent city that I drive through on the way home from work.”

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