Watch Live: Jay Powell Confirm Not Even Thinking About Thinking About Thinking Non-Dovishly
With ‘stonks’ screaming higher at record-er and record-er highs (and junk bond yields at record-er and record-er lows), some have suggested Fed Chair Jay Powell may feel some pressure to tamp down ‘rational’ exuberance during his speech today to The Economic Club of New York (on the state of the US labor market), which will be followed by a Q&A.
However, he continues to get a reprieve as inflation – according to official measures – is all under control and not suggesting any over-heating. As BofA noted today:
Overall, there was a lot of negative noise in core CPI which we would recommend partially fading. Stickier inflation improved on the margin with healthcare surprising to the upside, but there may be some noise here as well and rents remained muted. We continue to believe that a sustained rise in inflation back to target will take time, likely being achieved by the end of 2022.
All of which means the likelihood that Powell says anything even remotely hawkish (or the least bit non-dovish) is as low as ever and his previous statement still holds firm:
“We’re not thinking about raising rates, we’re not even thinking about thinking about raising rates.”
However, the market is intensely focused on rates. As Dan Loeb wrote in his latest investor letter:
We are focused on interest rates, which will help define how and what type of assets “work” at the margin going forward.
The interaction between US nominal yield, the US real rate, and the effective difference between the two (e.g. inflation expectations) is our focus.
Loeb warns that inflation remains a chief concern.
Consensus is strong that,it will remain subdued given the high slack in the labor market but, if this is incorrect, the Fed will hike rates more quickly, shocking markets and challenging the recovery.
Additionally, as we detailed earlier, for investors banking on continuing massive stimulus, what unexpectedly lies ahead may not be the same as the road we have been traveling…
The coming financial plumbing problems are just starting to percolate. The Treasury has no choice but to limit debt issuance and reduce its cash balances.
Bottom line: short term interest rates are likely to go negative. That is unless the Fed takes action.
The Fed has been crystal clear they do not want negative rates. They prefer the Fed Funds rate to stay within its current target of 0.00-0.25%.
Below are four ways the Fed can drain liquidity in the money markets to offset the Treasury/Fed actions and try to keep rates positive:
It can limit purchasing short term debt and instead favor longer-term bonds.
They can take that a step further by selling short-term holdings and purchasing longer-term paper. Most recently employed in 2012, such an action is called Operation Twist. However, because it involves selling, the Fed must buy more than $80 billion a month in longer-term debt to meet its monthly goal.
The Fed may use its reverse repurchase program (RRP) to remove liquidity. RRP, is a temporary swap of cash for securities. In this instance, the Fed would provide banks Treasury Bills in exchange for cash, effectively draining liquidity.
A final tool in its toolbox is the interest the Fed pays banks on reserves (IOER). The current rate is .10%. The higher the rate, the more incentive for banks to sit on reserves and not lend them out. Reserves are the basis on which money is created. Therefore the Fed can prevent more cash from being created by keeping the IOER higher than similar money market investments.
The four operations above, or anything else they dream up, reduce liquidity. Any reduction of liquidity is ipso facto tightening.
And, as unlikely as it may be, Powell may just hint at that today, or be forced to address it during the Q&A.
If he does… brace!
Bottom Line (via RanSquawk):
We expect that Powell will rattle-off familiar lines about a cautious near-term outlook, the need for further fiscal support, how it is appropriate to keep monetary policy accommodative for the foreseeable future, etc, but the market may be focused on his inflation views in light of some recent criticism by notable commentators (former Treasury Secretary Summers), who warn that President Biden’s proposed fiscal package might risk stoking unwanted inflationary pressures.
Powell will likely emphasize that the conversation about normalization is premature at this stage given the amount of support that the economy still requires.
The extent to which Powell talks about the tools the Fed could use to manage higher yields (a function of higher inflation and inflation expectations) will be telling; some analysts expect Powell and Co to resume talking about tools like weighted average maturity extensions of asset purchases, and even a potential Yield Curve Target when it wants to keep the yield rise in check (the proverbial sticks the Fed could use to whack the market back in line with its guidance).
Watch Powell live (due to start 1400ET), click on image for link to Fed site, no embed available:
Wed, 02/10/2021 – 13:54