Powell: There Is No End In Sight To The Fed Reset

A lot of people expected Jerome Powell to defend his policy of extending the period of restrictive interest rates for an extended period of time and he did not disappoint them. The yield-curve inversion and what it means for the economy.

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Ka-Powell!

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As Federal Reserve Chair Jerome Powell was preparing to testify before Congress, it was widely expected that he would remain hawkish and lay the foundation for a higher terminal interest rate to be implemented. His policy of extending the period of time he spent in the restrictive territory for an extended period would be defended and he would largely stick to his script in most cases. All of these things were done by him and he fulfilled his end of the bargain. Even so, many people were still a bit surprised by just how hawkish the Fed chairman turned out to be.

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Hence, he was explicit in his statement that at the March 22 meeting, pending major economic news, he might raise the Fed's benchmark lending rate by a half percentage point. It was all the investors needed to hear.

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As Treasuries sank to fresh lows, traders are increasingly expecting the Federal Reserve to announce a half-point hike rather than a quarter-point hike, as swaps bets today indicate traders are more likely to expect the Fed to announce a half-point hike. It is estimated that this will cause key borrowing costs to rise by about 107 basis points in four meetings, to about 5.6% in the end. Based on deriving implicit predicted fed funds rates after each meeting from futures prices, we can see from the Bloomberg World Interest Rate Probabilities function (WIRP on the terminal) that the entire predicted curve was yanked up after each meeting. After Powell's last big press conference on February 1, when several rate cuts were already baked into the forecast, it is quite remarkable that the predicted course has changed.

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This may be interpreted as an abandonment of belief, still in circulation on Feb. 1, that it was possible to bring inflation down to target without creating major job losses or a recession if inflation was brought down to target. This seems to be a much more challenging task now. There has been a notable inversion and widening of the spread between the two-year and 10-year Treasury yields this week, which has so far been a reliable indicator of recessions. This is the deepest inversion since 1981, and it is a disquieting sign. Currently, 30-year yields are 111 basis points lower than two-year rates, a record difference between the two.

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For the first time since July 2007, the yield on the two-year Treasury note has increased to 5% for the first time in over a year. Traders adopted higher expectations for the peak Fed policy rate at the beginning of February as traders adopted higher forecasts for the peak Fed policy rate at the end of the month.

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It was no surprise that the stock market reacted immediately to Powell's prepared introductory remarks. Following the question-and-answer session, the S&P 500 Index closed down more than 1%, back below 4,000, after a few failed attempts to recover during the question-and-answer session.

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There was a big deal here, and - as was pointed out in the Points of Return yesterday - people in general hadn't expected that it would be that big. As Powell's appearance was scheduled for the middle of the month, it would appear that it would be difficult for him to generate any news, as there are still several major releases of data to announce before this month's Federal Open Market Committee meeting. This includes non-farm payrolls as well as consumer price inflation figures for February. In spite of what Powell has just said to Congress, these new data points have the potential to swamp what Powell has just said if they were to have the same impact on the outlook as the last data points in those series. 

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What made him so outspoken in the first place? There was an element of a reality check to it, in a way. The testimony of Seema Shah, chief global strategist at Principal Asset Management, appears to be an admission by the FOMC that it has fallen victim to the "old seasonality trick" in the face of somewhat subdued data for December.

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Yardeni suggests that these comments were truly different from what Powell had said earlier in the month, regardless of whether Powell did a poor job of communicating at the time, or whether a close analysis of his comments revealed that he had been more dovish a month ago. It can be argued that one of the good explanations for this can be found in the fact that January's data points were not only hot, but almost all of them were hotter than expected as well. This leaves a number of profound questions, which will be answered by the next set of data releases, rather than Powell's opinions on the matter.

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The Fed's inflation target is another talking point that has caught the attention of investors, along with Powell's insistence on the Fed's inflation target. It is back to the old debate on whether the Fed's inflation target can ever be achieved since he admitted there is a long way to go before inflation returns to 2%. It is essentially back to whether the Fed's inflation target can ever be achieved. Société Générale's Solomon Tadesse doesn't believe it to be the case. "Everyone is basically assuming that it will go down to that 2%, but in actuality, 2% is a very unrealistic target," he said, adding that it needs to be increased. 

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In spite of this, he noted that there is one caveat: “The Fed cannot do so at the moment because its credibility has been questioned,” he said. There must be a further tightening of the target before credibility can be established. But the discussion about reducing the target should take place by the end of the year. 

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It is likely that the Fed's next meeting will see the biggest shift in the "dot plot" where each governor's projection for where the fed funds rate will move over time is shown as a dot in the graph. For the first time since December, they are due to be updated for the first time since then. There was a shift upward in the dots between September and December, as shown in this chart from NatWest Markets.

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After Tuesday, there is a very high possibility that the median prediction for the end of this year will move upward once again, which is a very positive sign. Furthermore, it would be helpful if the committee's predictions for the years 2024 and 2025, which are at present scattered in a way that is difficult to comprehend, would begin to converge towards the high end of the current range of predictions in both years. In the longer run, what would be most interesting would be a shift in the dots to accept that the fed funds rate may not drop all the way back down to 2% in the future.

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