Powell Building Credibility
Doug Nolan
The guy sounds like a discerning traditional central banker.
Powell is an admirer of Paul Volcker’s fortitude, and he’s clearly drawing inspiration from the legendary Fed Chairman.
Markets are growing impatient.
It was a misstep for the FOMC to have inserted new language into its post-meeting statement: “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
Stocks rallied a quick 1% on the statement, assuming a newfound focus on “cumulative tightening” and “lags” signaled a shift in the committee’s thinking.
Inklings of such a turn had already been offered by Fed officials, including Bullard, Daly, Evans and Kashkari.
Markets could take comfort that the Fed was in sync with other central banks, with recent market instability forcing a reassessment of aggressive tightening.
Importantly, relieved markets were seeing confirmation that the beloved - but estranged - “Fed put” was back in play.
Now they just needed to hear it delivered from the lips of Jay Powell.
Powell’s head was elsewhere, perhaps drawing inspiration from the resolve Paul Volcker had demonstrated some 40 years earlier.
I respect and admire Powell.
His Fed has made historic mistakes, but he’s determined to try to make amends.
The Chair is doing what he knows is in our nation’s best interest.
He’s willing to take the heat.
Distinguishing himself from his predecessors (back to Greenspan), the Fed Chair is not kowtowing to the financial markets.
A further departure from the past: Powell’s a straight-shooter.
He probably planned on a balanced approach, though the more Powell earnestly answered questions, the more his inner Volcker came through.
“There’s no sense that inflation is coming down…”
“Rates have to go higher and stay higher for longer.”
“Here in the United States, we have a strong economy…”
“Our message should be, what I’m trying to do is make sure that our message is clear, which is that we think we have a ways to go; we have some ground to cover with interest rates before we get to that level of interest rates that we think is sufficiently restrictive.”
“We’re exactly where we were a year ago.
So, I would also say it’s premature to discuss pausing.
And it’s not something that we’re thinking about – that’s really not a conversation to be had now.
We have a ways to go.
And the last thing I’ll say is that I would want people to understand our commitment to getting this done.
And to not making the mistake of not doing enough - or the mistake of withdrawing our strong policy and doing that too soon.
So those, I control those messages and that’s my job.”
“Now you see services inflation, core services inflation moving up, and I just think that the inflation picture has become more and more challenging over the course of this year, without question.
That means that we have to have policy be more restrictive, and that narrows the path to a soft landing, I would say.”
“I don’t have any sense that we’ve over-tightened or moved too fast.
I think it’s been good and a successful program that we’ve gotten this far this fast.
Remember though that we still think there’s a need for ongoing rate increases, and we have some ground left to cover here and cover it we will.”
“In the United States, we also have a demand issue.
We’ve got an imbalance between demand and supply, which you see in many parts of the economy.
So, our tools are well-suited to work on that problem, and that’s what we’re doing.”.
“We’ll want to get the policy rate to a level where it is, where the real interest rate is positive.”
Powell repeatedly emphasized the strong labor market.
“Overall though, the broader picture is of an overheated labor market where demand substantially exceeds supply.
Job creation still exceeds, sort of the level that would hold the market where it is.
So that’s the picture.
Do we see, we keep looking for signs that sort of the beginning of a gradual softening is happening, and maybe that’s there.
But it’s not obvious to me because wages aren’t coming down.
They’re just moving sideways at an elevated level, both ECI and average hourly earnings.”
“I don’t know that the channels through which policy works have changed that much.
I would say a big channel is the labor market, and the labor market is very, very strong.
Very strong.
And households, of course, have strong balance sheets.”
“I think no one knows whether there’s going to be a recession or not, and if so, how bad that recession would be.
And our job is to restore price stability so that we can have a strong labor market that benefits all over time.
And that’s what we’re going to do.”
Powell pushed back strongly against the criticism that the Fed had already driven the economy into recession.
Interestingly, Powell also downplayed housing risk, a risk I believe is significantly greater than the Fed appreciates.
“I would say the housing market was very overheated for the couple of years after the pandemic, as demand increased and rates were low.
We all know the stories of how overheated the housing market was, prices going up, many, many bidders and no conditions, that kind of thing.
So, the housing market needs to get back into a balance between supply and demand…
From a financial stability standpoint, we didn’t see in this cycle the kinds of poor credit underwriting that we saw before the global financial courses.
Housing credit was very carefully, much more carefully managed by the lenders.
So, it’s a very different situation and doesn’t appear to present financial stability issues.”
How the Fed’s risk management focus has evolved is also noteworthy.
Powell repeatedly stated that the risk of not tightening enough greatly outweighs doing too much.
“And trying to make good decisions from a risk management standpoint, remembering of course that if we were to over-tighten, we could then use our tools strongly to support the economy; whereas if we don’t get inflation under control because we don’t tighten enough, now we’re in a situation where inflation will become entrenched and the costs, the employment costs in particular, will be much higher potentially.
So, from a risk management standpoint, we want to be sure that we don’t make the mistake of either failing to tighten enough, or loosening policy too soon.”
“Again, if we over tighten, and we don’t want to, we want to get this exactly right, but if we over tighten, then we have the ability with our tools, which are powerful, to, as we showed at the beginning of the pandemic episode, we can support economic activity strongly if that happens, if that’s necessary.
On the other hand, if you make the mistake in the other direction, and you let this drag on, then it’s a year or two down the road and you’re realizing inflation behaving the way it can, you’re realizing you didn’t actually get it.
You have to go back in.
By then, the risk really is that it has become entrenched in people’s thinking and the record is that employment costs, the cost to the people that we don't want to hurt, they go up with the passage of time.”
The S&P500 reversed 3.5% lower on Powell’s comments, and was down another 1.5% at Thursday’s opening.
After declining eight bps on the Fed statement to 3.97%, 10-year Treasury yields jumped to 4.11% on Powell.
Yields traded as high as 4.22% on Thursday (closed the week at 4.16%).
Yield curve gyrations were noteworthy.
After beginning the week with an inversion of 41 bps, the 2/10 Treasury yield spread was as much as 62 bps inverted in early-Friday trading – the biggest inversion since Volcker was in charge in 1981.
Global markets remain extraordinarily unstable.
After collapsing 57 bps the previous week, Italian yields jumped 29 bps this week.
Italian stocks (MIB) gained 3.3%, with Italian banks surging 6.2%.
European bank stocks rallied 4.1%.
Major equities index gained 5.8% in Poland, 5.2% in Hungary, and 3.4% in the Czech Republic.
Stocks were up 4.3% in Mexico, 3.2% in Brazil, and 2.0% in Columbia.
South Korea’s KOSPI Index recovered 3.5%.
In the currencies, the Brazilian real gained 4.7%, the Chilean peso 1.7% and the Mexican peso 1.4%.
November 2 – Bloomberg:
“Nobody is quite sure who wrote it, when it was written or if it’s even true.
But a screenshot of four paragraphs detailing a China reopening plan was enough for traders to scoop up stocks for two days running.
The unverified post, which contained black characters on a white background with no identifying marks, first began circulating on Monday night in WeChat…
By the next morning, it was spreading like wildfire.
The screenshot claimed that China’s No. 4 official Wang Huning -- one of seven men on the powerful Politburo Standing Committee -- held a meeting on Sunday of Covid-19 experts at the request of President Xi Jinping.
It called Xi ‘big boss’ and used ‘WHN to refer to Wang in a bid to sidestep censors, who strictly manage messages and social media posts on China’s political elite.
Representatives at the meeting, which included members of the economic and propaganda departments, discussed ‘speeding up a conditional opening plan, with the goal of substantially opening by March next year,’ it said.”
Hong Kong’s Hang Seng Index jumped 5.4% in Friday trading and 8.7% for the week – the biggest weekly gain since 2015 (from Bloomberg).
The Shanghai Composite rose 2.4% Friday and 5.3% for the week.
The growth-oriented ChiNext Index surged 3.2% and 8.9%.
Friday was an extraordinary day in the currencies.
The dollar index dropped 1.6%, the biggest one-day decline since March 2020.
The Chinese Renminbi jumped 1.62%, and the Offshore Renminbi surged 2.02% versus the dollar.
Bloomberg: “Chinese Yuan Has Its Best Day in Decades as Good News Piles Up.”
Let’s not get carried away.
It’s a Chinese mole hill of good versus a mountain of bad news.
Another Bloomberg headline: “China Stock Frenzy Enters Overdrive on Hopes That Worst Is Over.”
There are lots of rumors and some substance that China is moving toward relaxing “zero-Covid.”
November 4 – Reuters:
“China will make substantial changes to its ‘dynamic-zero’ COVID-19 policy in coming months, a former Chinese disease control official told a conference hosted by Citi on Friday...
Separately, three sources familiar with the matter said China may soon further shorten quarantine requirements for inbound travellers.
Zeng Guang, former chief epidemiologist at the Chinese Centre for Disease Control and Prevention who has remained outspoken on China's COVID fight, said the conditions for China opening up were ‘accumulating’, citing new vaccines and progress the country had made in antiviral drug research.”
China is moving to loosen travel and quarantine restrictions.
Also encouraging, Beijing has agreed to allow foreigners to be vaccinated with BioNtech’s mRNA vaccine.
China’s inferior vaccines and the prohibition of foreign mRNA vaccinations left the Chinese, especially its large elderly population and inadequate healthcare system, vulnerable.
The thought is that this could be a first step toward more effective vaccinations.
Clearly, Beijing has to relax “zero-Covid.”
And it makes sense that, planning ahead, they might target March for a potential loosening.
The developer collapse and housing downturn have attained powerful momentum.
Sirens must be blaring in Beijing.
Between now and March, China faces a perilous winter.
China reported 3,871 new cases Friday, the most since early in the Shanghai wave (May).
Moreover, infections are increasing in two-thirds of China’s 31 provinces.
There are also huge unknowns associated with the slew of new, highly transmissible variants.
I certainly understand the clamoring for positive news out of China.
Sentiment coming out of the national congress seemingly couldn’t have been more negative.
Markets were ripe for a short squeeze and bout of panic buying.
Beijing is now in crisis management mode, which is always a salve for the markets.
There is, however, clear potential for Covid to get a whole lot worse over the coming weeks and months – and Xi’s Beijing has way too much invested in “zero-Covid” to relax measures at this juncture.
And prospects for apartment markets and the Chinese economy over the winter are bleak at best.
As such, prospects for massive Beijing-directed infrastructure spending are looking good.
Relaxation of “zero-Covid” was credited for this week’s commodities price surge.
The Bloomberg Commodities Index rallied 5.1%, increasing y-t-d gains to 18.5%.
“Prices Up on China Optimism”; “Copper has Best Day Since 2009 as Metals Rocket on Dollar Drop.”
Copper surged 7.5%, Nickel 7.6%, Aluminum 6.5%, and Tin 4.3%.
Silver jumped 8.3%, Gold 2.3% and Platinum 1.7%.
Despite festering crisis dynamics, there remain strong inflationary impulses globally.
For the most part, commodities markets continue to be underpinned by strong demand and supply constraints.
Investment and speculative demand, however, have been recently restrained by the spiking dollar and downward spiraling Chinese fundamentals.
This week’s Chinese market squeeze, especially in the renminbi versus the dollar, provided a catalyst for a bit of a commodities buying stampede.
There will no doubt be ongoing volatility.
I wouldn’t be surprised to see a resumption of the commodities secular bull market.
Despite pockets of weakness (i.e. housing), the overall U.S. economy continues to demonstrate strong inflationary biases.
There’s a lot of focus on the size of the December rate hike, along with the so-called “terminal rate.”
The market is now forecasting a peak Fed funds rate of 5.09% for the May 3rd 2023 meeting.
I’m skeptical that 5% short-term rates will suffice in returning inflation to the Fed’s 2% target.
I see it more as the market’s estimate of how far rates can rise before things start to break.
While layoff announcements (especially associated with the bursting tech Bubble) are adding up, the greater U.S. economy is demonstrating resilience.
But I tend to view today’s resilience as a negative consequence of previous boom-time excesses.
Most corporations and the household sector are still living off QE cash and wealth effects.
Moreover, energized banking and “private Credit” sectors are lending at a record pace.
Never had it so good.
And while reduced from crazy Covid levels, federal deficit spending remains formidable.
The bottom line is that system Credit continues to expand at a rate sufficient to underpin excess demand while fueling inflation.
It’s also becoming increasingly clear that secular supply dynamics (i.e. “de-globalization”, China frictions and the new “Iron Curtain,” climate change…) point to sticky inflation even in the face of some waning demand.
New Cycle Dynamics.
And the Fed’s job is all the more challenging.
It’s increasing the likelihood of something breaking.
Securities markets have had a dismal year.
Yet, a Credit slowdown will actually mark the down-cycle’s onset.
And that’s when the economic downturn gathers pace, exposing weak bank and “private Credit” underwriting and other excesses.
It’s still early in the process.
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