Powell's “Transitory” Inflation Becomes Bullard's “Inflation Shock”
Macro, behavioral finance, emotional finance, central banks,
Seeking Alpha Analyst Since 2015
Over thirty years of taking the volatility out of uncertainty, by taking the uncertainty out of volatility, for proprietary trading desks, commodity trading advisors, sovereign wealth funds and private offices.
Summary
- Americans have started to worry more about the economy, rather than COVID-19, just as the latter re-emerges.
- The nominations of Powell and Brainard prioritize inflation above ensuing MMT.
- The nominations of Powell and Brainard have not drawn a line under the Fed’s independence problem.
- St. Louis Fed President James Bullard is the effective Fed Chairman for the duration of the taper phase.
- By the time that Mr. Market is done flattening the yield curve, to discount the negative economic effects of the accelerated taper schedule, he may have begged the question of whether the Fed should consider easing again.
rozkmina/iStock via Getty Images
“It’s the Economy, Stupid, or is it?” ….
Just when things appeared to be getting back to normal, COVID-19 has reappeared as the main threat. This time around, however, it appears that the Fed is not going to be fooled into overreacting with monetary policy easing. On the contrary, the Fed wishes to make things worse for a while in order to prevent high inflation from becoming the norm. The American consumer doesn’t care if it's COVID, or inflation, or the Fed that’s making him/her pessimistic. It’s all the same in the end, and the economy weakens.
According to the latest New York Fed Survey of Consumer Expectations Credit Access, the US Consumer is back to where he/she was in 2019, pre-COVID. It should be remembered that, back then, consumer animal spirits and the economy, in general, were ebbing. It should also be understood that, within the current data, the young and credit-poor are getting over-extended. In addition, there is a growing worry about liquidity and the ability to meet sudden shortfalls in finances. The data depicts an economy in which the supply of credit is tightening and is expected to tighten further. In this environment, the consumer, on aggregate, is cutting back demand for non-revolving credit and becoming more reliant upon revolving credit. The supply of said revolving credit is, however, being tightened.
The US consumer is, thus, challenged from the credit side in addition to being challenged on the consumption side from rising inflation. These growing headwinds are just about to, apparently, get reinforced by an accelerated Fed taper cycle. No wonder, then, that consumer confidence continues to fall back towards pandemic lows.
(Source: Gallup)
The latest Gallup Polls show that the American focus is turning towards the economy and economic situation of individuals within it.
(Source: the Author)
A previous report suggested that the White House may, soon, need to modulate its message away from COVID-19 and towards the economy going forwards. This suggestion seems to have been confirmed by the new Gallup data. Unfortunately, however, the latest outbreak of the Omicron Variant may complicate the situation by taking the focus away from the economy.
Inflation before MMT ….
The last report also discussed the two potential Fed Chairman candidates, in relation to this author’s view that either of the favorites will end up advocating for Modern Monetary Theory (MMT), once they have satisfied the markets that they have dealt with the current inflation problem. MMT, if it is to occur, must be framed as the answer to American concerns over the economy. If it can be shown that the MMT phase will begin from a base of well-anchored inflation expectations then so much the better.
(Source: the Author)
In relation to this well-anchored inflation base, the Fed is most likely to follow St. Louis Fed President James Bullard’s prescriptive Hawkish action for the taper. The clock is ticking.
The handling of the current inflation situation is crucial. If MMT is to be applied, eventually, the fiscal implications are dangerous unless inflation expectations are well-anchored.
(Source: the Author)
President Biden, reprising his “Sheriff Joe” persona, signaled his intentions to build the well-anchored inflation base by renominating Jerome Powell, for the Chair, and his capabilities to deliver MMT, once the base has been formed, by nominating Lael Brainard as Vice-Chair.
The mission was accepted, on behalf of both nominees, by Powell, with the solemn oath to “use our (the Fed’s) tools both to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched.”
Both nominees, apparently, prioritize dealing with inflation first. Senior White House economic adviser Heather Boushey only read the bit about the strong labor market, thereby, showing how equivocal the interpretation and framing of the Chairman’s message will be in practice. There is something for inflation fighters and monetary inflationists. Lael Brainard’s acceptance speech could be summed up as “broadly inclusive”.
Independence in theory, but not in reality ….
(Source: Bloomberg)
The legend, that goes with the nominations, is that the Fed remains autonomous and, hence, independent. President Biden has, allegedly, ringfenced the Fed and monetary policy from the current partisan maelstrom. If only this were true.
The inference is, that President Biden will not seek to influence the central bank, politically, with his nominations for upcoming vacant roles. The reality is, that President Biden, currently, lacks the political capital to get away with influencing the Fed.
(Source: Pew Research Center, caption by the Author)
Fed independence is a reassuring, fiction that, in reality, means that the central bank must now try to please both partisan factions. As noted in a previous report, said partisan factions are splitting into even more diverse sub-factions whom the Fed must now try and please. Political dysfunction and, hence, the Fed’s devolved credibility, is becoming even more diluted.
Fed independence is a reassuring, fiction that, in reality, means that the central bank must now try to please both partisan factions. As noted in a previous report, said partisan factions are splitting into even more diverse sub-factions whom the Fed must now try and please. Political dysfunction and, hence, the Fed’s devolved credibility, is becoming even more diluted.
President Biden’s nominations, do not draw a line under the Fed independence issue. In fact, they have effectively opened up the debate to the partisan milieu. The Fed will, now, become a political football.
With inflation anything but under control, the nomination of Brainard will be the contentious one. The dysfunctional partisan dynamics guarantee that her nomination will become contended.
Powell and the new monetary policy framework are legally compliant ….
(Source: the Author)
Powell will also be scrutinized closely by all, even painfully by Elizabeth Warren; especially in relation to his stewardship of the new monetary policy framework and his handling of the Fed’s QE-insider trading scandal.
This author has noted that Powell has prepared well for his grilling, by ensuring that he and his colleagues have, always, complied with the letter of the Congressional mandates in a strict legal sense. Thus, their compliance and intent were, always, legal even if the outcomes appear to have conflicted with their mandates. Powell was prescient of the partisan threats in the early days of the Trump presidency. Since then, the Fed Chairman has always trodden carefully and legally.
(Source: the Author)
Brainard has been an architect of the inflation target overshooting strategy, in the new monetary policy framework, which will be questioned in great detail by Congress. Congressmen also care about being re-elected. With inflation as the biggest concern in their voters’ minds, it is highly likely that they too will talk and act conservatively during the confirmation process for both Fed nominees.
Cometh the nominee confirmation, cometh the FOMC meeting, cometh the hour, cometh James Bullard ….
(Source: the Author)
The good news is that there is a great substitute on the bench to replace Brainard and even Powell, in the event that one of them falls. James Bullard has had a good track record, throughout the pandemic, and is the main protagonist of the strategy to deal with the current inflation issue.
(Source: James Bullard)
Cometh the FOMC Meeting, cometh the hour, and cometh the man. Bullard reiterated his thesis, lest people forget the progenitor, to the Fed team and the markets as the December meeting approached and Chairman Powell embraced his thesis. The thesis is now labeled with the “Risk Management” heading.
(Source: the Author)
Bullard’s prescriptive action has, effectively, been embraced at the Federal Board of Governors level. This has been further endorsed by the two nominees for Chairman and Vice-Chairman. So, who better to drive the process than Bullard himself?
The last report noted the inertia of the Regional Fed Presidents to embrace the new Hawkish agenda. With the nominations out of the way, the path of convergence is now clear. Atlanta Fed president Raphael Bostic was already well down this road already. His latest guidance shows that he is making rapid progress to its terminus of interest rate hikes. Bostic now fully endorses an accelerated taper timeline that ends with the beginning of conventional monetary policy tightening with interest rate hikes circa Q1/Q2 2022.
The release of the last FOMC meeting minutes showed that great progress has already been made towards the regional Hawkish consensus.
San Francisco Fed president Mary Daly still has some way to go before one could accuse her of being Hawkish. She has, however, budged slightly in the Hawkish direction of late. She will now agree to accelerate the taper schedule, conditional upon another strong employment situation report. She is also willing to engage in planning for interest rate hikes, right now, to be rolled out, later, if and when her employment tripwire is triggered.
Cleveland Fed president Loretta Mester is, now, right on point with the Hawkish consensus. She is willing to accelerate the taper, with the additional proviso that it is a prelude to at least two interest rate hikes, next year when it ends.
New York Fed president John Williams preferred to keep his cards close to his chest, pre-FOMC meeting. Whilst confirming that the pace of the taper would be the main item on the agenda, he would not say what pace he favors.
Richmond Fed president, and noted essayist, Thomas Barkin also agrees that it is time for the Fed not only to normalize monetary policy but, also, to consider accelerating the pace in order to adapt to the current inflation situation.
Outgoing Fed Governor Randal Quarles confirmed the Hawkish accelerated taper baseline at the Federal Reserve Board.
Atlanta Fed president Raphael Bostic feigned ambivalence to the latest resurgence of COVID-19 and the reciprocal global shutdowns. If he is to be taken seriously, Bostic actually intends to make the situation worse by accelerating the taper and rate hike schedule.
“Sheriff Joe” Biden’s global possie of strategic petroleum reserve releasers tried to frame perceptions of the alleged, Hawkish behavior of the Fed and related developed central banks.
Fed over-reaction becomes an elevated probability ….
The US President’s frame was supposed to hold a picture in which the Fed does not need to be as Hawkish if the global coordination is enough to halt the rise in crude oil prices. A stronger and more emotive frame was required and duly provided, in the form of the latest OPEC+ output increase compliance and the surge in the Omicron variant. A scenario in which the Fed now over-reacts with its accelerated taper is now very much in play.
(Source: Bloomberg)
In addition, the spirit of global coordination on strategic petroleum reserve sales was also, perhaps, supposed to take the sting out of what was becoming a dangerous trend in brinksmanship between America and its latest and greatest enemy.
US CPI says Hot, China says Not ….
Looking at the state of China’s economy, one can clearly see why it is in a mood to cooperate on attempting to suppress oil prices.
(Source: the Author)
If, as suggested by this author, the Fed needs to factor in the Chinese version of “Common Prosperity”, the PBOC has just warned the US central bank not to go overboard with its new Hawkish instincts.
(Source: Bloomberg)
As the year-end approaches and the crystal balls get scanned, for 2022 themes, China and its economy are catching the eye. The Sino-American 2022 thesis, under construction, is one of divergence at the geopolitical, diplomatic, and economic levels. Divergence, however, has its economic limits when global economic growth is threatened by it.
(Source: Bloomberg, caption by the Author)
The latest PBOC quarterly report has erased all references to normalized monetary policy. In addition, there have been some heavy hints from policymakers that they are not happy with the current bout of Yuan strength.
(Source: worldeconomics)
Some of the private survey data show that China’s eponymous “disorderly expansion of capital” is now a disorderly economic contraction. A good question is, how much of this contraction is self-enforced discipline and how much is externally inflicted. With his position at the helm secure, President Xi Jinping is unlikely to aggressively pursue economic growth. On the contrary, it is rumored that growth targets will be lowered, in order to provide a platform for deeper structural economic reforms. Whatever the answer, it is clear that the Chinese economy will not be a strong driver of global economic growth for the foreseeable future.
Jay says what Jim said ….
Chairman Powell’s recent Coronavirus and CARES Act testimony was his first public speaking event post renomination. It was, thus, his first opportunity to justify his renomination by articulating his way forward. His speech noted the strong recovery, and strong inflation, pre-Omicron outbreak. He also noted that the Omicron variant will, at worst, exacerbate the trends that have got the economy to where it is now. In his view, this is currently a position where the burdens, of high inflation, and poor employment opportunities, fall the hardest on the poorest.
(Source and caption by the Author)
Hence, it may be concluded that Chairman Powell sees inflation as the priority to be dealt with immediately. In other words, it is in the interest of the poorest Americans for the Fed to engineer an economic slowdown.
With their job security threatened, assuming that they have not already become unemployed, and their wage bargaining power eroded, the poorest Americans can, allegedly, take comfort in the fact that what little money they have will, allegedly, go further at the shops. Presumably, when they decide that this is no comfort at all, Chairman Powell will then tell them that he is aiming to overshoot a 2% inflation target, in order, to erode their purchasing power. Many of those in America’s largest cities will already be feeling the discomfort.
(Source: Bloomberg)
Apparently, those Americans currently feeling the pain have been feeling it since 2016 and possibly even longer. This is, presumably, one of the reasons why they voted for Trump and also why they then voted for Biden. Their sense of feeling abandoned must be truly overwhelming, as each subsequent President fails to deliver for them. The growing partisan nature of American politics speaks to this sense of abandonment. If the Gallup Polls are correct, this sense of abandonment is heading back towards the previous COVID-19 lows. The Fed is just about to accelerate the nudge towards this nadir.
This author would observe history rhyming again with the period when COVID-19 first hit the US economy. The poorest Americans fell further behind, during the pandemic, which then prompted the Fed to embrace the broadly inclusive bona fides that it has apparently just de-prioritized. It remains unproven that an economic slowdown is in the interest of the poor unless it is compensated with fiscal welfare payments. On the contrary, Chairman Powell may simply be doing what is best for financial assets, that the poor do not own, in the long run. Real returns to capital (and financial speculation) will, henceforth, continue to expand at the expense of returns to labor.
(Source: Bloomberg)
Warming to his task, Chairman Powell then went on to defend what remains of the Fed’s credible commitment, by way of affirming its alleged independence. This was always going to be a stretch. But, by signaling his intentions and capabilities to weaken the economy, Chairman Powell appeared to distance himself, from his Presidential re-nominator, at slightly more than arm’s length.
Powell’s affirmation was done by taking a leaf out of St. Louis Fed President James Bullard’s prescriptive manual. The word “transitory” has now, officially, nay legally, been dropped from the list of inflation descriptors. The Fed will consider accelerating its taper, at the next FOMC meeting, with potential rate hikes to follow. Furthermore, according to Powell, the conditions precedent for interest rate hikes will soon be met. There will be a risk to growth, but since this taper acceleration implies that it will be over sooner Mr. Market is encouraged, by Powell, to discount the lower inflation outcome now.
(Source: Federal Reserve Board)
Further valedictorian remarks, from outgoing Fed Vice Chairman Richard Clarida, then brought down the curtain, if not the house, on the latest Fed independence act. A nostalgic, and reflective, Clarida went through the annals of recent economic crises, noting that the Fed acts powerfully and consistently with its mandate. Allegedly, the Fed is always successful, in the end, too. Contriving to show that the Fed is only human, despite its superhuman track record, Clarida opined that the current level of inflation is not a Fed success. Neither is it a failure though. In fact, it is a signal that the Fed will taper successfully.
Better to travel, on the flattening yield curve, and alight before the Fed arrives at the end of it ….
(Source and caption by the Author)
Mr. Market was unnerved, but obediently discounted the economic softening signals emanating from Fed speakers with brio.
Loosely translated, Fed independence also means don’t fight the Fed when it’s making a labored point. If you don’t want to go with it, at least get out of the way. It will, now, be interesting to see if nominee Chairman Powell’s detractors are as hostile in questioning him, and his new monetary policy framework, in the aftermath of his recent Hawkish signals. Ostensibly, Powell has shown that he is tough and independent. He has also got the legal evidence to prove that he is legal and compliant with his Congressional mandates. Hence, the new monetary policy framework is also legal and Congressionally compliant, mutatis mutandis.
(Source: Bloomberg)
Bravo Mr. Chairman, vae victis.
If Chairman Powell ruefully, and privately, gives thanks to the Omicron variant and OPEc+, for their collective amazing sense of timing, it would not be so surprising. Others’ misfortune, oftentimes, favors the brave and the curve-flattener.
(Source: St. Louis Fed, caption by the Author)
The final piece of the taper puzzle fell into place with the latest employment situation report. There was just enough employment growth to support an accelerated taper decision at the December FOMC meeting. This strength was, however, not enough to automatically justify accelerated interest rate hikes to follow the accelerated taper. The risk that the Fed overcompensates and hurts the economy if it does follow through with rate hikes became elevated. The confluence of elevated probabilities conspired to flatten the yield curve further.
By the time that Mr. Market is done flattening the yield curve, to discount the negative economic effects of the revised taper schedule, he may have begged the question of whether the Fed should consider easing again. The global capital markets discounting mechanism will, most likely, be begging for rather than questioning the timing of said ease.
James Bullard thinks that the jobs report was “quite strong”. This could turn out to be the unintended, understatement of this year and early next year! There was no understatement in his use of the words “Inflation Shock” to replace the forbidden word “transitory”.
(Source: Bloomberg, caption by the Author)
Bullard swiftly discounted the headline weak nonfarm payrolls number, with his expectation for future higher revisions. Since Chairman Powell has signaled that Bullard is making the taper calls, and the rest of the team are in play, the Fed’s desire for consensus will, now, most likely, move its center of policymaking gravity from cognitive dissonance towards self-confirming tapering bias. Fortunately, the damage from this new, consensual, cognitive bias will be short-lived; since the yield curve is swiftly moving to discount the carnage faster than the Fed can create it.
Contrarians take note.
(Source: Bloomberg, caption by the Author)
The US yield curve can still flatten, but the US Dollar will, soon, no longer continue to strengthen, in correlation with it, once the risk currencies have bombed out at the Fed’s hands. This bombing out phase has been unofficially occurring ever since the Fed fell behind the taper curve (“by at least two quarters”).
(Source: the Author, caption by the Fed)
In this author’s view, the Fed had been dissonant, lacking in consensus and dangerously factional, in addition to being at least two quarters behind the taper sweet spot. Substantial further progress has, recently, been made on the dissonance, consensus, and factionalism. The taper sweet spot has been missed, however, so that remedial attempts to reverse-engineer a hit risk overkill on both the markets and real economy.
(Source: investing.com, caption and the Author)
Now that the Fed is officially catching up, the risk currency bombing out phase is already approaching its end; even as it garners some ugly headlines and collateral victims. With the Fed perennially arriving late, it is always better to travel than to arrive. It is also better to get off early and buy a ticket in the opposite direction if/when one disembarks early. With these thoughts in mind, Goldman’s swift revision lower for US GDP is apposite rather than prescient.
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