The Great and Powerful Powell Has Spoken
Like the Wizard of Oz, Federal Reserve Chair Jerome Powell’s influence is amplified by optics and subjective perceptions. And like farm girl Dorothy, the average American is naive. Most of your fellow citizens couldn’t identify Powell nor tell you what the Fed does. And yet, Powell’s pronouncements affect millions of lives and trillions of dollars.
On Wednesday, the Fed made public its long-awaited decision on monetary policy and afterwards Powell held his customary press conference. As I explain below, the stock market did not respond favorably.
The Fed’s policy-making arm, the Federal Open Market Committee (FOMC), announced Wednesday that the central bank would hike interest rates by 25 basis points (bps), which is 0.25%. The decision among FOMC members was unanimous and widely expected.
The FOMC’s post-meeting statement asserted: “The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.“
That wording differs from previous statements which indicated “ongoing increases” would be appropriate to dampen inflation. This more dovish tone comes amid a banking crisis that has raised concerns about the financial system’s stability.
With this latest increase, the Fed’s target interest rate is set in a range between 4.75% and 5.00%, its highest level since 2007 (see chart).
The unfolding banking crisis has eased, but it nonetheless puts Powell and his policy munchkins in a tough spot. They want to tighten enough to wring inflation out of the economy, but the recent spate of bank failures underscores the harm that rising rates already are wreaking.
Failed financial institutions such as Silicon Valley Bank were caught in a vise: customers withdrew money in droves because rising rates caused cash crunches for their businesses, but rising rates also led to losses among the long-term bonds in which the banks had parked their cash.
It was overly optimistic to expect the Fed to stand pat on rates Wednesday, as some analysts had predicted. Powell wants to maintain his credibility as an inflation fighter; the ghost of Paul Volcker is whispering in his ear. But due to turmoil in the global financial sector, a higher hike of 50 bps was taken off the table.
Wall Street hates surprises and the Fed handed out no surprises. On the initial news of the rate hike, markets rose. But as he spoke, Powell dispirited investors by alternating (as is his wont) between a hawkish and dovish tone. The main U.S. stock market indices closed lower Wednesday, as follows:
- DJIA: -1.63%
- S&P 500: -1.65%
- NASDAQ: -1.60%
- Russell 2000: -2.83%
Regional banks were the worst performers on the S&P 500. All sectors, and all 30 Dow components, closed lower. The benchmark 10-year Treasury yield slipped below 3.50%.
Off to see the wizard…
In his comments to the press Wednesday afternoon, Powell said:
“We believe…that events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and business, which would in turn affect economic outcomes. It is too soon to determine the extent of these effects, and therefore too soon to determine how monetary policy should respond.”
Powell also noted that inflation was “well above” the Fed’s target of 2% and although inflation has moderated, upward price pressures remain. He said he was “strongly committed” to bringing inflation to the central bank’s target.
The upshot: Powell has prioritized inflation over banking turbulence.
The full effects of the Fed’s tightening have yet to wend their way through the economy, while stricter credit conditions arising from banking woes will exacerbate headwinds. A prerequisite for a durable economic recovery, and an end to this bear market, is for the Fed to move to the sidelines.
Problem is, the Fed maintained a zero interest rate policy (ZIRP) for too long to counteract the COVID-induced economic slump, and now it’s erring on the side of hawkishness to make up for its prolonged easy money stance.
If and when a recession does occur, it will largely be an artifact of policy, with a coterie of unelected bureaucrats choosing to toss people out of work and bankrupt businesses to dampen inflation.
But events don’t always pan out in textbook fashion. Much of the inflation we’re suffering today results from the havoc caused by the pandemic and the Russia-Ukraine war, two variables beyond Powell’s control.
The banking crisis that has been grabbing headlines stems from a dearth of liquidity, which in turn has been caused by Fed policy. This week, some lawmakers on Capitol Hill (from both political parties) accused Powell of causing gratuitous damage to the economy.
Stock market trading was choppy Wednesday. Indeed, a report released March 21 by the Centre for Policy Research found Powell’s press conferences to be three times more volatile for the markets than those under his predecessors Janet Yellen and Ben Bernanke. Powell’s talkative color commentary often spooks investors, as it did today.
At one point in the 1939 movie, the Wizard of Oz admits ruefully: “I’m just a very bad wizard.” History will judge whether the same can be said of Powell.
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John Persinos is the editorial director of Investing Daily.