Fed chair Powell must be wary of a market running ahead of itself
Jay Powell was one of the architects of the Federal Reserve communiqué that ignited the “taper tantrum” — a flash of acute volatility that swept across financial markets. Six years on, the central banker — since promoted to chair from board member — is again confronted with the risk of causing convulsions as traders ratchet up expectations for deep cuts in interest rates.
According to fed funds futures data, investors expect the Fed’s main rate will drop to just above 1 per cent by the end of next year. In other words, markets are braced for the equivalent of four quarter-point cuts over the next year and a half.
That could be overdoing it. The Fed cut rates late last month for the first time since 2008, in what Mr Powell insisted was a mere “mid-cycle adjustment.” Policymakers are due to lay out their rate and economic forecasts at the next policy meeting, in mid-September. In June members of the rate-setting panel predicted that the main rate would end 2020 at 2.1 per cent, foreshadowing the rate cut announced in July but pencilling in no further reductions over that period.
The market’s divergence from the Fed’s stated intentions leaves Mr Powell in an uncomfortable position ahead of the central bank’s annual economic symposium in Jackson Hole, Wyoming next week. Treasuries have added $1tn in market value in the past eight months alone: Any snapback could shake markets and tighten financial conditions just as the global economy is showing signs of strain.
The situation today echoes the spring and summer of 2013, when Mr Powell was one of the “three amigos” who had become uneasy with the Fed’s vast bond purchasing programme given the extent of the recovery from the 2008-09 recession.
Mr Powell, then a new governor, implored fellow policymakers to set the stage for a reduction in bond buying to show markets that the central bank was serious in its pledge to react to incoming data.
“We’ve got to jump,” he told his colleagues during the June 2013 meeting, referring to making a formal announcement on tapering the bond purchases.
Later that day, Mr Bernanke told a press conference the Fed planned to “moderate” its bond buying, building on Congressional testimony he made the previous month that had already begun rattling Wall Street.
The market reaction was swift and fierce. US government debt sold off, equities dropped and the dollar soared. Ructions in financial markets rippled to Main Street, raising the 30-year mortgage rate by half a percentage point in a week.
Speaking earlier this year alongside his predecessors, Janet Yellen and Ben Bernanke, Mr Powell admitted that the taper tantrum “left scars” on everyone working at the Fed at that time. “The possible economic consequences were troubling,” Mr Bernanke reflected in a memoir.
Recent market gyrations suggest the cost of miscommunication could be even greater this time round.