Photographer: Samuel Corum / Bloomberg
Photographer: Samuel Corum / Bloomberg
Federal Reserve Chairman Jerome Powell is likely to try to convince financial markets that are suddenly skeptical on Thursday that the central bank will be over-cautious in withdrawing its support for the economy after the pandemic is over.
Instead of trying to limit the rise in long-term interest rates, Fed observers hope that Powell will use his participation in a Wall Street Journal webinar to reaffirm the Fed’s determination to meet its renewed employment and inflation targets, while maintaining the looser monetary policy for longer, and of course he would like to avoid a repeat of last week’s messy bond market.
“It is not a question of trying to calm the market,” said JPMorgan Chase & Co. chief economist in the United States, Michael Feroli. “But you want interest rates to be in line with the Fed’s objectives.”
This is important for the health of the economy in the long run. If the markets and the Fed are in sync, they will work together to achieve the central bank’s goals of maximum employment and average inflation of 2% under its new strategic framework.
Long-term interest rates have soared this year – the yield on the 10-year Treasury bill was 1.48% at 4:50 pm in New York on Wednesday, down from less than 1% in early 2021 – how a wider spread of vaccines to fight the virus and the promise of increased government spending has fueled expectations for much faster economic growth in the future.
Brainard patient
In what was potentially a preview of Powell’s comments, Governor Lael Brainard emphasized on Tuesday how far the Fed was from meeting its goals.
“We have a lot of ground to cover”, she said a Foreign Affairs Council webinar. “It is appropriate to be patient.”
Brainard said the speed of last week’s moves in the bond market “caught my eye”, adding that she would be concerned if she saw cluttered deals or a persistent tightening of financial conditions that could slow progress towards the Fed’s targets.
In testimony to Congress on February 23 and 24, Powell played down concerns that rising yields would hurt the economy, rather than declaring them a “statement of confidence” in the outlook.
Read more: ‘Dude, get back to your desk’: the week that clouded the bond markets
The markets exploded the next day, with the yield on 10-year Treasury bills rising briefly to 1.6%.
Investors also raised their expectations for the Fed’s first rate hike until the beginning of 2023, when they began to question the central bank’s commitment to keep the policy easy until inflation exceeds 2%.
“The beginning of 2023 seems to me very early,” said Goldman Sachs Group chief economist Jan Hatzius, who does not expect an increase until 2024.
PGIM Fixed Income Chief Economist Nathan Sheets said this would not be the last time the Fed would be faced with escalating long-term interest rates. He sees 10-year yields rising to 2% during the summer, before falling at the end of the year.
The Fed has a variety of ways to respond to a rising yield, if it sees fit.
Watch: Danielle DiMartino Booth, CEO of Quill Intelligence, discusses the chaotic sale of Treasury bonds last week, the outlook for the economy and Fed policy.
Guidance Lite
First more words will come. Call it direct guidance.
The central bank is currently buying $ 120 billion in assets per month – $ 80 billion in Treasury bills and $ 40 billion in mortgage-backed debt – and has pledged to maintain that pace “until substantial progress” is made. towards your goals.
To help anchor incomes, policymakers can be more explicit about when they will start to reduce purchases. Fed vice president Richard Clarida took a step in that direction last week, suggesting that the current pace of buying would be appropriate for the rest of 2021.
Policymakers could also be more definitive about what it would take to raise interest rates. They said they will keep rates close to zero until the labor market reaches the maximum level of employment and inflation rises to 2% and is on track to moderately exceed that level for some time. But these limits are somewhat amorphous and open to interpretation.
After the words, the action would come. The Fed could either step up its bond-buying program or shift purchases of mortgage-backed bonds to Treasury bills.
Operation Twist
Another option: a replay of Operation Twist, in which the Fed eliminates its holdings of Treasury bills and places the money in longer-term bonds. This would have the added benefit of easing downward pressure on account fees, which threaten to become negative.
The Fed could also emulate its Australian counterpart and take control of the yield curve, seeking to limit yields on short-term Treasury bills – a strategy that Brainard spoke of with approval in the past.
Wrightson ICAP LLC Chief Economist Lou Crandall said Powell needs to be careful not to undermine expectations for interest rates embedded in the Treasury market. The Fed’s next Economic Forecast Summary, which will be published after its March 16-17 economic policy meeting, may show an increasing number of policymakers planning a rate hike in 2023.
Powell could instead highlight the Fed’s new modus operandi for monetary policy under the framework he adopted last year.
“He may try to draw the market’s attention to how much regime change has occurred in the Fed’s thinking,” said Crandall.
– With the help of Craig Torres