Fed: Gamestopped

Published on January 27, 2021

It was an unusual first of the year press conference earlier this afternoon for Federal Reserve Chairman Jerome Powell after the conclusion of the Federal Open Market Committee’s two day January meeting.

Two broad observations, after we thought about it for a while:

** First, Chairman Powell stayed firmly as he could on the dovish messaging as we expected (SGH 1/26/21, “Fed: “No Time Soon”): no near term changes in the Fed’s rates and balance sheet policy, and for the umpteenth time, he stressed it is hugely premature to talk about the “Exit,” so stop asking.

** When that time for the exit is approaching — on a distant horizon – Fed officials will telegraph well in advance their intentions for what is likely to be an extremely gradual tapering of asset purchases. “After the global financial crisis,” he noted, “we raised interest rates, we shrank the balance sheet size. We can do that again. We learned a lot from that experience.”

** In line with the dovish messaging script, there was an awful lot of “transience” assumed in Fed’s expectations for developments through the year that, taken together, diminish hawkish caution or concerns: as last spring’s hammering of prices rolls out of the data, for instance, a rise in measured inflation this spring should be fairly unsustained through the year, leaving aside for a moment what could be fast-rising consumer inflation expectations.

** Likewise, housing prices do indeed look to be rising sharply, but that too will prove to be a transient feature and for that matter, the surge in savings, portending a potential burst of repressed spending and with at least a good chunk of it making its way into the stock market, is also likely to be a transient upward pop that will be run down as supply will meet the rise in aggregate demand in a vaccinated economy.

** “What is holding [the economy] back is not the lack of policy support from the Fed. It’s the pandemic,” the Chairman said to reassure. “If you look at the sectors of the economy that are interest rate sensitive, you’ll see strong activity, housing, durable goods, automobile sales. Our policies are working and we think our policy stance is right. That said there’s clearly more we can do.”

** But the second thought we came away with this afternoon was a sense that where the reporter questions were going – and if you will, the market zeitgeist – was not to question how much the Fed has done to support the interest-sensitive sectors of a Covid-ravaged economy, or how it has broadened its definition of maximum employment to run the economy hot as possible, or even what it could still do, but whether the Fed is doing too much?

** The question Fed officials may be forced to grapple with later this year, and perhaps sooner rather than later, is whether the current balance sheet policy, — scooping up $120 billion a month in treasuries and mortgage paper or $1.44 trillion annualized —  can really be sustained for another year or more without inflating asset prices to dangerously unsupportable levels? Does the economy really need $120 billion of asset purchases per month, or can the Fed gently and gracefully do less without upending the financial markets?

** Indeed, against the backdrop of the crazytown surges and swings in Gamestop and a handful of other ‘populist” stocks, it was only natural that the very first question to Chairman Powell was about asset bubbles, and reporters repeatedly rotated the taper issue around financial stability and macroprudential policy questions. The Chairman at one point had to ask a reporter to “remember we are focused on maximum employment and price stability.”

** We could go on in dissecting his measured responses to deflect the financial stability questions, but the one that caught our attention came when he was asked point blank whether monetary accommodation was fueling an asset bubble, and he said well, no, “the connection between low interest rates and asset values is probably something not as tight as people think,” and he added that there were other causes of the market exuberance, the vaccines and fiscal policy were the new news drivers.

** The harsh reality is that there is little the Fed believes it can do to directly challenge the pricing or risk taking or leverage in both the stock and bond markets. To be sure, both the Fed and Treasury officials are intending to work as quickly as possible to further strengthen bank capital adequacy and even to slowly bolster the resilience of the core non-bank financial institutions. It will take a while.

** But with bond prices still rising, credit spreads tightening, and stock markets soaring (at least before today), it is little wonder so many in the markets and, if truth be told, a few Committee members as well, are nervously thinking through the potential pitfalls of even hinting at a gradual withdrawal of the massive monthly additions of liquidity, much less actually cutting back.

There was, for us, an unintended après moi le deluge tone to the Chairman’s remarks by the time he wrapped up the one hour presser that may prove to be a scene setter for the rest of the year.

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