Powell Or Pozsar?

Jerome Powell is going to “keep pushing” until US inflation abates in “a clear and convincing way.”

“If that involves moving past [neutral] we won’t hesitate at all to do that,” he added, while discussing policy during a Wall Street Journal event on Tuesday.

Powell didn’t offer anything new, per se, but he did acknowledge that the Fed “probably” should’ve raised rates sooner. On Monday, Ben Bernanke called the Powell Fed’s hesitation “a mistake,” in hindsight.

There’s a sense in which the market probably wants the Fed to move aggressively. Powell’s blunt refusal to countenance the idea of 75bps rate hikes when queried about larger increments during this month’s post-FOMC press conference was initially greeted with a rally in risk assets. But by the next day, things were unraveling anew. Some suggested a suddenly lively long-end was indicative of the inflation tail risk.

In any case, Powell also acknowledged that the “landing” he’s variously suggested can still be “soft-ish” might in fact be “a little bumpy.” That admission “was somewhat confidence-inspiring insofar as the Fed is recognizing the risks,” BMO’s Ian Lyngen and Ben Jeffery said. “Just as long as the wheels don’t come off — because sometimes that happens too.”

Suffice to say the deafening recession chorus suggests many market participants believe the wheels are likely to come off, notwithstanding reassurances from Fed officials who’ve been keen to emphasize the underlying vitality of the domestic (if not the global) economy.

The Fed seems committed to the fight, irrespective of collateral damage. If they deliver, it’ll be the most dramatic tightening impulse in decades (figure above).

At the Journal event, Powell described the US as “well positioned to withstand tighter monetary policy,” but conceded that “there could be some pain involved in restoring price stability.” “Pain” is a euphemism for a higher unemployment rate. The crux of the debate is whether the Fed can siphon millions of superfluous job openings without triggering actual job losses.

Powell said he was pleased that markets are responding to Fedspeak. That response in 2022 is exemplified by rising real rates and falling stocks. Financial conditions, Powell mused, have tightened “quite a bit.” The figure on the left (below) illustrates the tightening impulse as it’s manifested in Goldman’s gauge.

The figure on the right (above) shows the rapidity of the surge in real yields and the impact on equities.

“Powell’s comments didn’t reveal anything materially paradigm shifting… other than an affirmation that neutral will not represent the Fed’s finish line as the Committee does what’s necessary to contain higher prices,” Lyngen went on to say.

Jim Bullard, meanwhile, called the US labor market “super-strong.” “It looks like we are on course for 50 basis points at coming meetings,” he told an energy industry conference, adding that although the Fed “want[s] to do this in a way that is transparent” and avoids “disruption,” volatility in financial markets and repricing in assets is inevitable.

That repricing — whether in stocks, homes or crypto — is now seen as a shadow policy objective. To be bullish is to fight the Fed.

Back in February, Zoltan Pozsar declared the need for a “Volcker moment.” “”Volatility is the best policeman of risk appetite and risk assets,” he wrote. “To improve labor supply, the Fed might try to put volatility in its service to engineer a correction in house prices and risk assets — equities, credit and Bitcoin too.”

He was trying to be provocative. “We recognize that what we are saying is extreme,” he wrote, before saying that in his view, “the Fed will soon incorporate some version of this thought process.”

Ultimately, they did just that, and Pozsar elaborated in his latest. “The market does not know what to price,” he said, adding that (abridged),

This uncertainty is feeding volatility and a selloff in equities and crypto assets. And that is a good thing from the perspective of a Fed that wants to see financial conditions tighten. The Fed is keeping the market on the edge. Consider the idea that the Fed is pursuing demand destruction through negative wealth effects: If low rates, forward guidance, QE and low volatility nurtured risk assets and demand by design, then hikes, constructive ambiguity, QT and higher volatility will hurt risk assets and demand by design too. Rallies could beget more forceful pushback from the Fed — the new game. At 4,000 [on the S&P], the Fed does not seem content, and in the grand scheme of things, this is where the Fed would change its tune if it would still be writing a put. At 3,500, we would have lost all of the post-pandemic gains in market wealth, but that level for stocks still feels like a put option, just with a lower strike price. At 2,500, we would lose not only all of the post-pandemic gains, but would eat into some of the pre-pandemic gains too. And if something indeed happened to the supply of labor post-pandemic (and some of that is wealth related), then to cool price pressures, maybe a pre-pandemic wealth level is appropriate indeed.

Pozsar was clear that his remarks weren’t intended to be “a target for stocks.” At Credit Suisse, that’s the purview of Jonathan Golub.

Again, Pozsar is being deliberately provocative. Some might suggest that’s his modus operandi these days. Whether sharing his thoughts on the evolution of the Powell Fed’s “Volcker moment” or updating the progress bar on his “new monetary world order” thesis, Zoltan seems enthralled. With his subject matter, yes, but also with himself.

Zoltan’s notes are embellished — cartoonish even. In the same “dispatch” cited above, he included an eye-rolling recap of his job interview with Bill Dudley, during which the two “finish[ed] each other’s half sentences.” (Twinsies!)

Dudley, like Zoltan, has kept himself in the news recently. Last week, he accused the Powell Fed of “sugarcoating” the reality of aggressive policy tightening. In March, he called a US recession “inevitable.”

In the May vintage of BofA’s Global Fund Manager poll, respondents identified hawkish central banks and recession as the top rail risks.

Survey participants expect almost 8 hikes this cycle and assessed monetary policy as the biggest potential risk to financial market stability.

Asked about the strike price of the “Fed put,” respondents said 3,529 is the approximate level on the S&P that would compel a policy pivot (figure above).

“I’m not blessing any particular day’s readings but it’s been good to see financial markets reacting in advance based on the way we’re speaking about the economy,” Powell said Tuesday. “We like to work through expectations.”