Powell Era Arrives as Fed's Gradual Pace Looks Ripe for RethinkBy
Top financiers voice worry about bubbles, Fed’s dovish stance
Incoming Fed chair has mandate to add more clarity to policy
The American labor market is sizzling, inflation more broadly in the U.S. looks like it’s perking up and even a decade-long global economic recovery looks ready to shift into a higher gear.
No pressure, Jerome Powell.
As Janet Yellen prepares to step aside as the Federal Reserve chair this week and hand the levers of monetary policy to Powell, her gradual approach to interest-rate hikes aimed at countering a fragile recovery and low inflation looks increasingly timid. The leadership transition at the world’s most powerful monetary authority comes just in time for a fresh approach.
Powell takes over as stocks worldwide are soaring and rising commodity prices are lifting emerging markets -- so much so that the International Monetary Fund has raised its 2018 world outlook, buoyed by rebounds from Europe to Brazil. Adding to the momentum are U.S. tax cuts timed to further stoke consumer spending and propel companies already boosting investment.
The Fed, though, is straitjacketed when it comes to timing its policy moves. While no one expects the U.S. central bank to raise interest rates when the Federal Open Market Committee announces its decision on Wednesday, investors are anticipating about three rate hikes this year, timed to coincide with meetings when press conferences are scheduled. It’s a constraint Powell may need to address soon as his Fed debates the need to speed up the pace of policy tightening or stay on track.
“We are in a pretty good place right now economically, but we’ve got a monetary policy that still seems like it is in the remnants of a Depression era,’’ Jes Staley, the chief executive officer of Barclays Plc, said in Davos, Switzerland, last week.
Bankers at the forum in the Alps sounded more worried about asset bubbles, and what happens when they pop, than an inflation rate that Fed officials have regarded as too low and meriting a go-slow policy.
“Bubbles are building,” Axel Weber, UBS Group AG chairman and former president of the German central bank, said in Davos. “The impact of this current monetary policy on markets, rather than just on inflation, is something central banks have to focus a bit more on at this point.”
Powell has an opportunity to refocus the message. Financial markets bet that he continues Yellen’s “what-me-hurry?” approach to policy. There are good reasons to be cautious. Central bankers don’t precisely know where the policy rate begins to bite down on growth, and if they tighten too quickly they could choke the upswing.
What has to change, some economists said, is the way that his Fed signals responsiveness to economic conditions that could brighten more quickly than expected.
“The issue is: Is the Fed nimble enough?” said Vincent Reinhart, chief economist at Standish Mellon Asset Management in Boston and a former senior Fed adviser. “They don’t give evidence of being data-dependent or making decisions meeting by meeting.”
There are few successful examples of a central bank smoothly warning markets it could shift to a more aggressive posture. The long shadow of the Fed’s 2013 Taper Tantrum cautions against abrupt moves. Yields on U.S. 10-year notes jumped by more than a percentage point over several weeks after then-Fed chief Ben Bernanke said it would start trimming its monthly bond purchase program.
At the same time, gradualism carries risks: reducing volatility, and setting up conditions for spending and borrowing based on potentially over-optimistic assumptions. That was the lesson from the Fed’s experiment with “measured” pace forward guidance when it raised rates in predictable quarter-point steps between 2004 and 2006.
Despite five rate increases under Yellen, who began the hiking cycle in late 2015, the Chicago Fed’s Financial Conditions Index is at the lowest levels since the early 1990s.
“We have had the opposite of a taper tantrum -- a substantial net easing of financial conditions,” said Ethan Harris, head of global economics research at Bank of America. “The message of the Fed is starting to look a bit stale.’’
There are at least three ways Powell could signal more sensitivity to changing conditions.
The Fed holds eight scheduled policy meetings a year and he could hold a press conference every time to explain his thinking, instead of after every other meeting, which is current practice. Investors see much less chance of a policy move at non-press conference meetings, despite repeated insistence from the Fed that each one is “live” for action.
“If they wanted to just show up and do a press conference, they could,” said Seth Carpenter, a former senior adviser at the Fed in Washington who is now chief U.S. economist at UBS Securities in New York. “The probability of going to eight press conferences a year could be pretty high” under Powell.
Second, the statement is over-reliant on officials’ baseline forecast. Its boilerplate guidance says “economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate.” That doesn’t say anything about the weight officials give to other outcomes and how that might be shifting now.
That leads to the third way Powell could change communications. He could talk about prominent risks to the outlook and how the Fed might respond, said Andrew Levin, a Dartmouth College professor and former Yellen adviser.
It’s a “what if” exercise that the Fed staff already provides to policy makers before every meeting, he said.
“Powell has a mandate to make the Fed more systematic and more transparent -- that is what many members of Congress have wanted to see,” Levin said. “I think Powell can move things forward.”
— With assistance by Theophilos Argitis