Jerome Powell, Chairman of the Federal Reserve, speaks at the Eisenhower Executive Office Building in Washington, D.C., United States on Monday, November 22, 2021.
Samuel Corum | Bloomberg | Getty Images
If the Federal Reserve meets expectations next week and announces a more aggressive unwinding of economic stimulus measures, it will mark a major change of course for the Federal Reserve and Chairman Jerome Powell.
In fact, the Powell Fed is almost as well known for its abrupt changes of direction as it is for the unprecedented incentives it provided during the pandemic.
"What the Fed has demonstrated is the difficulty in making forecasts through both committee and consensus," said Joseph LaVorgna, Natixis chief economist and former head of the National Economic Council under former President Donald Trump. "In market jargon, the Fed bought the high and sold the low. So I think there will be a credibility problem going forward."
At its two-day meeting next week, the Fed is expected to say it will double the pace of its bond purchases, while it is also likely to point to more aggressive rate hikes in 2022. The moves are in response to inflation, which is stronger and longer lasting than Fed officials expected.
LaVorgna fears, however, that after months of calling inflation "temporary", the Fed is now making the mistake of overestimating its duration and tightening at the wrong time. This could mean that officials have to switch back again next year if the current inflation trend runs out of steam.
A history of the pivots
This would be at least the fourth such postponement for an institution that prides itself on forecasting and communicating, and that provides a reliable roadmap for market participants and the public.
But the whipsaw nature of the US economy is wreaking havoc.
A Fed that had pledged to hike – or "normalize" – rates in 2018 had to change its stance the following year when global weakness hit. The central bank then closed 2019 with Powell and his colleagues who insisted they had cut enough and were confident that rates would stay stable for the foreseeable future.
The pandemic changed all of that in 2020, forcing interest rate cuts and expansionary monetary policy that would eventually result in the Fed adding more than $ 4 trillion to its balance sheet.
Later that year, however, the Fed would step in again and announce a paradigm shift in which it would focus its efforts more on jobs and be ready to tolerate higher inflation. The Fed promised to hold loose until it made "significant further headway" toward employment that was not only full, but also cross-gender, cross-race, and cross-income.
It is this final step that brings the Fed to its current crossroads: with price hikes to more than 30-year highs, the Fed is now expected to resume its role as inflation fighter.
Where once market participants talked about the “Powell Put” or the willingness of the Fed to set a lower limit in the event of market declines, the new conversation could revolve around the “Powell Pivot”.
But with politics so unpredictable and predictions often proving to be unreliable, the Fed could face a significant credibility challenge if it switches gears again.
"The world is changing"
"This bears eerie similarities to December 2018 in the sense that the Fed says one thing and the markets say the other," LaVorgna said, referring to the Fed's most recent rate hike cycle, which ended with the worst Christmas Eve sell-off on Wall Street.
Indeed, US Treasury bond yields remained remarkably stable despite all the rumors of rate hikes looming next spring after the Fed ended its monthly bond-buying program. The bond market has also lowered its 5- and 10-year inflation expectations, albeit from historic highs in mid-November.
Traders have preferred the timing of these hikes, however, and expect a two – and maybe three – quarter percentage point increase in 2022.
In general, stocks tumbled in November – mainly due to pandemic fears – but the Fed's monetary policy volatility doesn't seem to bother too many investors.
"I think it adds to their credibility. The world is changing among them," said Mark Zandi, chief economist at Moody & # 39; s Analytics. "The Fed is doing exactly what it has to do. Trying to thread the needle."
Powell was able to reach a consensus to move faster to dismantle the extremely accommodating monetary stance of the pandemic era. Last week he showed a sense of economic diplomacy by saying it was time to step back "temporarily" to describe inflation.
Even some of the more reluctant Fed members or those advocating simpler policies have acknowledged that it is time to put the brakes on.
San Francisco Fed President Mary Daly said in mid-November that "the best policy is to recognize the need to wait," noted last week that reducing bond purchases "is certainly something I expect would that we could see ”and rate hikes earlier than announced by the Fed consensus in September.
"The pandemic has just turned everything completely upside down and mixed up again and again," said Zandi. "It would be shocking if the uncertainty among investors at this point in time, with all this happening, wasn't higher. Investors seem to be of one mind, namely to buy."
In fact, Zandi said that a little less clarity on policy isn't too bad given the high stock market valuations.
While Alan Greenspan's Fed always left the markets in the dark as to what it was doing, the Powell Fed was ultra-transparent, trying to telegraph all of its movements, which are usually aimed at helping financial conditions, no matter how frothy.
"If I had a criticism, I think it would be a little too focused on investor opinions," said Zandi. "They follow. I think they need to lead a little more."