The Chairman of the Fed is widely viewed as one of the most influential and powerful people in the world of finance. When he speaks or writes, people parse and explain every comment that he makes. Jerome Powell is the 16th chair of the Federal Reserve and has held the position since February 2018. Perhaps none of his predecessors has seen a more unbelievable time. He is known as a very collaborative and apolitical figure and recently, was interviewed on 60 Minutes.
John Behof is someone I have worked with for over 20 years who has been involved in many different parts of the banking industry, perhaps for this topic, most relevantly as a regulator. John graciously offered to share some of his thoughts on the recent Powell interview—he gave me a lot of new perspective; I hope he does for you, too.
The FED Wants to Hold your Hand
The first record I ever bought was a song entitled "I Want to Hold Your Hand," by the Beatles. It was a 45, which had one song on the front and one song on the back. When I was watching 60 Minutes this past week, this song came to mind. You may have noticed that Jerome Powell, the Chairman of the Federal Reserve, went on 60 Minutes to explain the FED's position on economic conditions. In addition, the Vice Chairman and other FED governors scheduled speaking engagements over the days right after his 60 Minutes appearance aired. This seemed to me to be a coordinated effort to get out the FED's "calming" message widely and strongly. And what was the message? The message was that despite all the trillions of stimulus spending, trillions of FED bond buying, very positive economic numbers, and direct evidence of inflation, everything is under control. The message was that any concerns that the FED (or the federal government) should ease off the pedal to the metal approach to advancing the economic recovery are misguided.
Watch the interview here.
They said inflation is increasing but assured us that until we hit an aggregate 3%, this is in fact a good thing. Inflation, they tell us, will settle down when things get back to normal and: cheap goods are flowing again from China, price competition returns, and productivity comes back. Their message is that these increases in prices are "transitory" and will settle down once we get back to normal. In addition, to get inflation to "average" 2%, which they think is ideal, you have to let it run above 2% for a while. Their actual fear is that once inflation does settle-down, it will settle down below 2%. It appears that the FED's lesson from the last recession is that the prospect of a long period of slow growth and deflation and disinflation should be much more worrisome than too much growth and too much inflation.
You see, the FED is very concerned that the bond markets have priced in an expectation of a not-so-transitory robust economic recovery and inflation regime. The FED's own economic forecast went up dramatically from January to March (their projections for GDP growth is now at 6.5% for 2021 and an unemployment below 6%.) Despite the FED's best efforts to keep rates low, the long-end of the Treasury curve sold off fairly dramatically between December 2020 and March 2021 (the 10-year went from 0.90% up to 1.75%; for now, it has settled back to 1.55%.) The 30-year mortgage rate went from 2.68% to 3.08% over that same period. The FED is unhappy that the markets, despite the FED's pontifications to the contrary, are starting to price-in more inflation than the FED is predicting and pricing in a stronger and quicker economic recovery than the FED is predicting; this makes them unhappy because it leads to a buildup of the loud and influential minority who are saying that rate hikes will come sooner than the FED says they will.
So, the FED is unhappy with the return of the "bond vigilantes," who are saying to the FED, more or less:
"We hear what you are saying, but we are seeing what we are seeing, and your "pedal to the metal" actions may be too much for the economy to bear. In the long run, you are on the verge of overheating this economy and all the bad that comes with it."
So, what can the FED to do to calm the vigilantes, and get those rates back in line? They are currently purchasing $120 billion of bonds every month, which is historically huge, and have been doing so for over a year. Increasing that activity could send out the wrong message, that maybe the recovery is failing. They could shift some of their buying from the short end to the long end of the curve, but the weakness in most of the short-end auctions makes that strategy risky. A short-end sell-off could really make the vigilantes more credible. The bottom line is that the bond investors on the longer end of the curve are getting antsy and fearful and have been pushing back by demanding more yield before they buy.
So, what is the FED to do? They can't buy more bonds; they can't shift their purchases. They can't stop the government spending. They can't stop the daily evidence that prices are increasing at a rate that appears to be higher than FED expectations. They can't stop the numerous economic releases that show the economic recovery is going very well, and may turn out to be much more robust than the FED is predicting. They can't stop the daily reports of how many people have been vaccinated and how ahead of schedule they are. So, what is the FED to do? How can the FED keep the pedal to the metal without allowing the bond vigilantes to push those long-term rates higher and higher?
Well, it appears the Fed has decided to try harder to get their message out and make you believe it. The bond vigilantes can't get time on 60 Minutes or give four speeches in one week, each with a hundred reporters in the room to get their point of view out there. But the FED can. The FED has decided that a public relations campaign will help them calm the markets.
On 60 Minutes Powell said (again, I paraphrase):
Any observed excess inflation is temporary, and the FED will let it run above 2% to get it to settle at 2%;
The economy is going well and the recovery is going well, but is not in danger of over-heating—we have a long way to go to get back to where we were;
The FED is being diligent about monitoring of the recovery and stands prepared to do what is necessary to keep the recovery going, but is carefully monitoring everything else; and
The FED knows the pedal is to the metal but won't let anything bad happen. But the worst thing it could do would be to react too diligently and quickly and get in the way of a solid recovery.
In addition to Powell's handholding on 60 Minutes, the next day FED Vice-Chair Richard Clarida gave a long speech echoing Powell's sentiment in more technical terms. Additionally, other FED governors made comments, from the same song sheet. So, the FED's answer to the fearful and antsy bond vigilantes and the run-up in long rates is a communications blitz to convey that the FED is on top of this recovery, is monitoring inflation closely, and does not anticipate the need to take the pedal off the metal for a long time yet. They are still on schedule and that there still will be no rate hikes until at least 2022 and very likely not until 2023. Nothing has changed in the FED's view, even though many bond market participants were pricing in a lot more inflation and a quicker recovery than the FED forecasts. Essentially, the FED's pundits are saying, "How can the FED's response and actions at the height of the pandemic be the same as now when we are nearly out of the woods?" Doesn't make sense.
So, on April 15th, when a series of good economic data was released, including a pretty high inflation number, and the 10-year rallied from 1.62 to 1.55, many were surprised. It almost seems counter- intuitive. Those numbers would normally be bearish for bonds, but they weren't. It appears the FED's public relations campaign is working; its power to provide handholding and thereby calm the bond market by just talking widely, loudly, and publicly has been effective. It remains to be seen if the bond vigilantes have been temporarily sidetracked, have become believers, or are hiding in the bushes planning a new foray.
They used to say the "pen is mightier than the sword." In this day and age, that might be updated to say, "media exposure is mightier than the monetary toolbox."
I want to thank John for his insights—the next 12 months should be very interesting. If you have specific questions for John, he can be reached at firstname.lastname@example.org.
Final, final thought: Every once in a great while, I feel a need to go to Taco Bell. It always tastes good, but it's also never a very good idea. It's kind of like selling cheap options…
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