(Bloomberg) – Federal Reserve Chairman Jerome Powell is heading into what could be his final year at the top of the central bank, determined not to repeat the mistake he made when he was a decision maker new to monetary policy seven years ago.
Then Fed governor Powell was among those leading the charge to scale back the central bank’s quantitative easing program – a stance that led to the economically debilitating and market-tearing tantrum taper of 2013.
Powell, whose four-year term as president ends in February 2022, will likely appear more cautious this week about limiting the Fed’s massive asset purchases – even though the economic outlook has improved further thanks to a strong expected budget increase from President Joe Biden.
“He will emphasize that the risk of moving too early far outweighs the risk of moving too late,” said Lou Crandall, chief economist at Wrightson ICAP (LON 🙂 LLC. Powell will hold a press conference on Wednesday after a two-day meeting of the Federal Open Market Committee that is expected to decide to keep monetary policy ultra-easy to combat the economic fallout from the pandemic.
As 2013 showed, picking the right time for a cone can be critical. After then-Fed Chairman Ben Bernanke suggested in May of the same year that the central bank could soon start to curb QE, long-term interest rates soared, upsetting markets. emerging markets and restricting the US economy. Bernanke’s comments came just weeks after an FOMC meeting in which Powell expressed hope that the Fed could start cutting asset purchases in June, according to a transcript of that meeting.
“Could the Fed decline without a tantrum?” JPMorgan Chase & Co. (NYSE 🙂 General Manager John Normand and his fellow strategists asked in a Jan. 22 note to clients. Their response was “unlikely given current valuations and positioning” in financial markets.
A Bloomberg survey of economists last week revealed a wide dispersion of opinions on when the Fed will begin to curb its buying. While a plurality of 35% expect typing to start in the first three months of next year, just over a quarter believe it will occur in the last three months of 2021. About 25% will not see it until the second trimester. from 2022 or beyond.
The Fed is buying many more bonds today than it was seven years ago. It currently buys $ 120 billion per month – $ 80 billion in treasury securities and $ 40 billion in mortgages – compared to $ 85 billion per month in 2013, including $ 45 billion in treasury bills.
But just like it was back then, the Fed has set a rather amorphous guideline for QE policy. In 2013, the FOMC said it would continue to buy bonds “until the labor market outlook has improved significantly amid price stability.” Now he says he will buy at least $ 120 billion in assets per month “until further substantial progress has been made towards the committee’s maximum employment and price stability goals.”
As Powell noted seven years ago, such vague indications increase the risk that markets misunderstand the Fed’s intentions. “The lack of clarity around our stop asset purchase rule is in itself a risk to financial stability,” he said at the March 2013 FOMC meeting, months before the comments Bernanke’s won’t shake the markets, according to the discussion’s transcript.
As they were in 2013, investors could again be surprised mid-year by the strength of the economy, this time due to more widespread vaccinations, said Robin Brooks, chief economist at the Institute of. International Finance. A bond market liquidation could be compounded by an increase in sales of Treasury debt as the government funds the fiscal stimulus.
“They can be overwhelmed by how quickly markets can move,” Brooks said of the Fed.
Another similarity between 2013 and today: a potential change in the leadership of the Fed. Bernanke was out seven years ago and nervousness about his potential successor may have contributed to the bond market’s fall, according to Brooks.
As 2021 advances, financial markets are likely to focus more on Powell’s fate. This could worsen inflation nervousness among investors by increasing uncertainty about future policy, Mellon chief economist Vincent Reinhart said.
For what it’s worth, economists expect Powell to stay at the Fed: About three-quarters of those polled by Bloomberg said they expected Biden to offer him another term.
The Fed chairman admitted that his fears in 2013 about the risks posed by QE turned out to be misplaced.
“The taper tantrum left scars on anyone who worked at the Fed at that time,” Powell said at the 2019 American Economic Association annual meeting. “I was one of those who raised concerns when I first came to the Fed” about asset purchases. While it was appropriate to raise them, they didn’t really bear fruit. We have not seen high inflation. We haven’t seen asset bubbles, ”he said.
The takeaway from this episode is that “markets can be very sensitive to opinions on the balance sheet,” he added.
What Bloomberg Economics Says:
“BE expects the general theme of the January meeting to be consistent with Powell’s recent public comment that now is not the time to talk about an exit from politics. Instead, he will emphasize that the Fed is ready to provide additional support to the economy, mainly through even more aggressive asset purchases.
– Carl Riccadonna, Yelena Shulyatyeva, Andrew Husby and Eliza Winger. For the full note, click here
That’s why he now promises to give investors enough time to digest any policy change.
“We will be communicating very clearly with the public, and indeed we will be doing so well before we actively consider starting to gradually reduce asset purchases,” he said in a January 14 webinar.
Despite these efforts, a sharp rise in long-term interest rates is “virtually inevitable,” according to former New York Fed Chairman Bill Dudley. As the Fed cuts and ultimately eliminates its bond purchases, investors will demand higher yields to fill the void, the Princeton University senior researcher wrote in a Bloomberg opinion column on Jan.21.
“There is no reason for the tantrum to be unduly damaging,” provided the Fed is prepared to respond if necessary by halting the cut or delaying its initial interest rate hike, Dudley added. “It will only feel bad about the resting bond market that we have seen since the start of the pandemic.”
© 2021 Bloomberg L.P.