Does the Fed have a credibility crisis?
Before you answer, let me give you the context. Because when posed in the broadest sense, the answer is probably just “Yes, absolutely.” In fact, most critics (and when it comes to the Fed, everyone’s a critic) insist the Fed has multiple credibility crises. To the institution’s many detractors, America’s inflation nightmare is just the latest in a long list of Fed failings that includes everything from facilitating bubbles and exacerbating inequality to embedding moral hazard in markets to habitually overstepping statutory boundaries.
But for our purposes here, “credibility crisis” refers to the rather stark juxtaposition between the December Fed minutes, which contained a rare rebuke of markets, and Jerome Powell’s conspicuous failure to echo that rebuke on Wednesday when given the opportunity.
The account of the December policy meeting, released early last month, said, of the easing in financial conditions that unfolded in November, “because monetary policy work[s] importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.”
According to Goldman’s widely-cited gauge of US financial conditions, the easing which played out in January (when the dollar fell, yields receded and equities surged) was roughly on par with the episode chastised in the December minutes. And yet, when asked Wednesday about looser financial conditions, Powell delivered what some viewed as a half-hearted, boilerplate rejoinder. By the end of the session, the dollar was lower with yields and the Nasdaq was 2% higher.
“The Chairman faced multiple questions about financial conditions and in essence, he denied they have loosened in the past five months [even as] The Goldman Sachs Financial Conditions index is at its easiest level since August 26th (Jackson Hole), The Bloomberg US Financial Conditions index is at its easiest level in nearly a year [and] The Chicago Fed’s National Financial Conditions index is at its easiest level since April,” JonesTrading’s Mike O’Rourke remarked.
He cited myriad recent evidence of speculative behavior across markets, before ultimately lamenting that Powell’s “denial that financial conditions have eased and his choice to measure progress against the easiest financial conditions environment of modern financial history simply provided a green light for the speculation to continue.” That, O’Rourke suggested in the title of his note, might’ve hurt the Fed’s credibility at a critical juncture in the inflation battle.
Writing just hours ahead of Powell’s press conference, Nomura’s Charlie McElligott noted that “the ‘worst of the worst’ equities” have been “squeezing / exploding +40% higher” of late. Those names include high vol stocks, and companies with leveraged balance sheets, high short interest and “anti-quality” features.
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