The Fed will normalize policy “as we move through 2022,” Jerome Powell told US lawmakers on Tuesday, during his confirmation hearing.
Although he emphasized that the Fed will cease growing the balance sheet in March, as planned, he was careful to avoid telegraphing anything about a date for the onset of runoff, saying only that it’ll commence “perhaps later this year.”
The US economy, Powell said, “no longer needs or wants” highly accommodative policies. But the market does. Stocks “need” loose policy because multiples clearly reflect deeply negative real rates and asset prices always “want” a generous Fed. Powell knows that all too well. As he put it during policy deliberations way back in 2012, “it will never be enough for the market.”
He went on to express some consternation about the size of the balance sheet, calling $9 trillion “far above where it needs to be.” The figure (below) is updated through last week. I always say the same thing: The balance sheet versus SPX chart is a cliché, but it’s a poignant cliché.
Powell confirmed that runoff will come “sooner” and proceed “faster” than it did in the last cycle. Earlier in the session, Loretta Mester told Bloomberg she’d back liftoff in March, while Raphael Bostic said runoff should start “fairly soon.” Esther George, meanwhile, revealed her “preference” for runoff starting “earlier rather than later.”
None of the above was “news,” per se. Stocks were initially ambivalent and eventually pressed higher. A March hike is fully priced, and Monday morning’s ephemeral tech rout pushed the Nasdaq to the brink of a technical correction. Mechanical flows turned the tide and there appeared to be some genuine dip-buying interest on Tuesday.
It’s not so much that additional losses for equities can’t materialize. Rather, it’s that it seems far-fetched to suggest the Fed is currently considering a 50bps move, which means the assigned probabilities are effectively maxed out for now, while the long-end looks a semblance of stable following last week’s fireworks. Obviously, Wednesday’s CPI print loomed large and Thursday’s PPI report will be parsed relentlessly too. But assuming in-line reads on both, there’s just not much scope left for officials to lean any more hawkish than they already have.
“It is my feeling that tactically, relative to positioning and what’s already priced, that in the absence of fresh ‘upside surprises’ in either inflation or jobs data, it will be increasingly difficult for much more incremental bearishness to be priced-into USTs / Rates without some new ‘accelerant’ catalyst,” Nomura’s Charlie McElligott said.
“The rise in real rates thus far has only triggered modest weakness in the equity market,” BMO’s Ian Lyngen and Ben Jeffery remarked. “Arguably, this controlled slide in stocks is precisely what the Fed would like to achieve as the Committee readies to apply the brakes to the real economy,” they added.
Of course, controlled demolitions are very difficult for policymakers to pull off, whether in the context of markets or vis-à-vis the broader economy. “If we’re lucky, the Fed will slow things down, and we’ll have what they call a soft landing,” Jamie Dimon told CNBC on Monday. “It’s going to be a little bit like threading a needle.”
Or not, if they can’t manage it. As discussed here, the lesson from 2018 is that rolling, mini-VaR shocks are just as likely (if not far more likely) than any soft landing.
Notably, Powell on Tuesday said the Fed hasn’t ruled out becoming an active seller of balance sheet assets. Specifically, he said no decision has been made. He needn’t worry. The market will make that decision for him. The answer will be “No.”
The whole situation must be a truly surreal experience for Powell. During the 2012 policy meeting mentioned above, he told colleagues that “the dealer community is now assuming close to a $4 trillion balance sheet.” “The question, why stop at $4 trillion?”, he asked. “The market in most cases will cheer us for doing more.”
Now here we are, a decade and $5 trillion in asset purchases later.
“The market will make that decision for him. The answer will be “No.””
LOL
I wish someone had the temerity to ask Chairman Powell “Just how will higher interest rates temper inflation? How does that work?” and as a follow-up to his wiggly answer “And who will it impact most?” Get it out there explicitly.
It’s not Elon Musk.
Meanwhile, to put it into context here’s an interesting observation from Edmunds about the average used car price hitting $29,011. “For the first time anyone can recall, more than half of America’s households have less income than is considered necessary to buy the average-priced USED car.”
If expectations for Fed getting more hawkish are “maxed out” in the near term, and at the same time Fed has made such a fast/hard hawkish pivot in recent days that it can’t credibly start talking less hawkish for awhile, does that mean the “Fed factor” is kind of pinned in the near term? Absent a dramatic change in inflation trend (like suddenly dropping < 5% or jumping > 10%).
While I’m glad that the Fed is finally acknowledging that runaway inflation needs to be corrected, now we’re on the flip side of 5 months ago. Then they said they thought inflation was transitory and not worth dealing with, now they are dealing with it but not telegraphing to what degree. Assuming this is a technically driven policy normalization, what specifically are they targeting with the policy moves? X% reduction in home prices, used cars, risk assets, etc? Without a target then they are really just playing with fire in my opinion, one that could burn the whole damn city down.
The Fed needs precise arthroscopic tools to operate on the economy, but find only axes and hand saws in their closet. Hopefully they don’t go all medieval, a la the “cure” for the participation rate is an engineered downturn to wring the newly-found courage back out of labor, thereby preserving profit margins, exec pay packages and index levels.
@furious one – spot on there.
If a CB is worried about home price inflation, just tweak mortgage down-payment rules on second, third and buy-to-rent purchases. Most other central banks use that lever. Why doesn’t the US Fed do so?
Because it would work, Derek!