This Is Jerome Powell’s Moment, No Matter Who Wins
By Nicholas Jasinski
This week, amid a tumultuous U.S. election, the Washington leader who has done more than any other to stabilize the U.S. economy and steady markets will go about his business as usual.
On Wednesday, Federal Reserve Chairman Jerome Powell will lead the Federal Reserve’s instrumental decision-making panel, the Federal Open Market Committee, in a two-day session on the economy and monetary policy. For investors, Powell is arguably a more important figure in Washington than whoever will occupy the White House come 2021.
Faced with a pandemic that has forced Americans to stay in their homes and shut down their businesses, the Fed, under Powell’s leadership, acted swiftly to prevent a major financial catastrophe from unfolding. The central bank cut interest rates to near zero, unleashed enormous bond-buying programs, deployed new lending facilities, and went far beyond what any Fed had done in the past.
No major change in Fed policy is expected this week—or in the months to come. Yet monetary policy is set to remain a steadfast support for the U.S. economy, and a backstop that takes the worst-case financial-market outcomes off the table. At the center of that will be Powell, whose term runs until February 2022.
As a recovery begins to unfold, his next steps will be to try to return Fed policy to a stance that resembles normal—although that will mean something very different in a post-Covid-19 world. How the central bank can wean the market and the economy off the support it has provided during the pandemic will be its most critical challenge in the coming years.
Guiding its approach will be a rethinking of the central bank’s goals that recently has been completed under Powell. The way that officials react to inflation and unemployment indicators will change in the coming economic cycle.
“His lasting legacy I think will be the important shift in the orientation of Fed policy,” says Peter Hooper, Deutsche Bank’s global head of economic research, comparing it to the Paul Volcker Fed’s quashing of inflation. “It’s as important as what Volcker did in the 1980s. There will be risks, but I think that shift is something Powell will be remembered for.”
There are limits, however, to what monetary policy can do—something that Powell has clearly recognized. With the economy still in the grips of the pandemic, the Fed chairman has been a frequent and vocal advocate for more fiscal stimulus from Congress. And that at times has threatened to drag him into the more turbulent waters of politics.
President Donald Trump has backed off on his criticism about Powell in recent months, after a long spell of berating him on Twitter for not cutting interest rates to below zero. In August 2019, at the height of U.S.-China trade tensions, the president even asked, “Who is our bigger enemy, Jay Powell or Chairman Xi?”
Despite Trump’s recent approval, it is unclear whether Trump or Joe Biden would renominate Powell when his four-year term expires. If Biden is elected, there would be a recent precedent: President Barack Obama nominated Ben Bernanke for a second term in 2009.
Still, Powell, 67, has shown himself able to remain cool and calm when the political brickbats are flying, and to keep a laser focus on the economy.
“He’s a pragmatic pivoter,” says Edward Yardeni, an economist and president of Yardeni Research. “He’s done what he set out to do, and [shown a willingness to] change his mind depending on what the situation demands, but not be totally inconsistent.”
It may help that unlike many of his predecessors, Powell doesn’t have a background as a Ph.D. economist who spent years in the halls of academia. A graduate of Princeton University and Georgetown Law, Powell had stints as a federal appeals court clerk and at two law firms, before moving to investment banking.
He then served three years at the Treasury Department under President George H.W. Bush, rising to undersecretary for domestic finance in 1992.
He joined the private-equity firm Carlyle Group in 1997, focusing on industrial company buyouts. In 2005, he set out on his own, founding Severn Capital Partners the next year.
Powell joined the Fed board in 2012 under Obama. Trump selected Powell to be chairman, and he began his four-year term in February 2018.
At first, Powell largely continued along the path of his predecessor, Janet Yellen. That meant gradually increasing the federal-funds rate, which had dropped to near zero during the global financial crisis.
At that time, policy makers worried about getting ahead of impending inflation and having room to cut rates in a future crisis. The Fed raised interest rates by a quarter of a percentage point four times in 2018 and began to reduce the size of its $4.5 trillion balance sheet by allowing bonds to roll off to the tune of $50 billion a month.
That monetary tightening drew fire from critics who pointed to uncertainties in the economic outlook. No detractor was more vocal than Trump, who repeatedly called for lower interest rates to match negative rates in Europe and Japan.
Powell managed to avoid addressing the president’s criticism directly, emphasizing the Fed’s independence and saying that it would do what the economic data demanded.
“In retrospect, the way he handled the criticism from the White House was telling about him as a person—that he didn’t sway,” Deutsche Bank’s Hooper says.
Trump did eventually get his wish, however. In early 2019, Powell said that the Fed would be “patient” with regards to further rate increases and gradually reduce its balance-sheet roll-off.
“When the situation changed and global economic weakness threatened to spill over to the U.S., he led the committee to back away from their previous path,” says Donald Kohn, a former vice chairman of the Fed and now a senior fellow at the Brookings Institution. “That’s what you have to do.”
Powell’s pragmatism was tested when the Covid-19 crisis hit. In between scheduled meetings on March 3, the Fed lowered the federal-funds rate by half a percentage point, followed by a full point less than two weeks later, to a target range of zero to 0.25%—as low as possible without going negative.
It also promised to buy hundreds of billions of dollars of Treasuries and mortgage-backed securities, reduced bank reserve requirements, and unveiled programs to maintain dollar liquidity worldwide.
In the following weeks, Congress passed the Cares Act, a $2.2 trillion economic stimulus bill that also funded lending facilities for the Fed to extend emergency credit directly to large and small businesses and municipalities. And the Fed began to buy a wider range of securities, including corporate bonds, commercial paper, and municipal debt—some through exchange-traded funds.
“I give the Fed very high marks for its Covid response,” says Sonal Desai, chief investment officer of Franklin Templeton Fixed Income and a member of the Barron’s Roundtable. “They’ve gone further than people thought was possible, quicker than people thought was possible.”
The Fed barely got started unwinding measures put in place to combat the financial crisis. Will it be able to remove the Covid-crisis support?
In late August, at the Kansas City Fed’s virtual Jackson Hole symposium, Powell unveiled a new approach to inflation targeting that will govern the central bank’s actions in the coming recovery.
Rather than trying to get ahead of rising inflation that theory dictates will appear once the unemployment rate falls below a certain threshold, the Fed could allow prices to run hot for extended periods to make up for shortfalls in the past.
And allowing unemployment to fall as close to zero as possible, as it did before the pandemic, extends more of the gains of the expansion to minority and lower-income groups.
In essence, the Fed won’t be removing the punch bowl when the party warms up—to paraphrase former Fed Chairman William McChesney Martin—but will wait for last call.
Time will tell whether the Fed’s new policy approach—called flexible “average inflation targeting”—will be successful. So far, the bond market does not appear persuaded.
Long-dated Treasury yields have hardly budged since the Jackson Hole speech, and they aren’t pricing in any significant inflation over the coming years.
But the new framework should be enough to give the market and investors confidence that Fed policy will remain supportive for years, while also giving Powell room to adjust based on what happens in the real economy—another pragmatic move.
“I would call it ‘constructive ambiguity,’ ” Desai says. “They haven’t put into place some kind of mathematical formula that would tie their hands. They’re giving themselves maximum flexibility, while still comforting the markets.”
Others are not so sure. “The consequence of these repeated interventions is that the Fed is expected to intervene everywhere,” says James Grant, founder and editor of Grant’s Interest Rate Observer. “When there’s a new crisis, will the Fed intervene with yet a bigger balance sheet and with yet a lower interest rate? So the question, to my mind, is where does it end? And I don’t know.”
Powell has pushed boundaries in another way, becoming one of the loudest cheerleaders in Washington for another fiscal stimulus package. Without ever going so far as to recommend the size, content, or timing of a potential bill, he has emphasized the need for support from Congress, as have other Fed governors. That has invited criticism about eroding the independence of the Fed.
“I think the Powell Fed has remained independent of any political pressure itself,” Yardeni says. “But with the Fed calling for more fiscal stimulus, they have lost any claim to total independence.”
The calls for fiscal stimulus also reflect how monetary policy is already nearly full-tilt easing. Powell and other Fed policy makers have expressed skepticism about the effectiveness of negative interest rates, but have implied that there is more that can be done in the realm of asset purchases, or via the Fed’s lending facilities. That may become necessary if greater borrowing-funded fiscal policy does lead to higher bond yields down the road.
Still, Congress’ spending powers are arguably better suited to combating a health and unemployment crisis than the Fed’s lending or interest-rate powers can be.
Under Powell, circumstances demanded asking more from monetary policy than has ever been asked before, and much of his legacy has already been cemented by his speed and willingness to act during the Covid-19 crisis.
Although likely to be less eventful, the way that Powell steers the Fed under its new framework and weans markets off the extraordinary measures in the coming years may leave just as large a mark.
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