Photographer: Samuel Corum / Bloomberg
Photographer: Samuel Corum / Bloomberg
Federal Reserve Chairman Jerome Powell is likely to try to convince financially skeptical financial markets on Thursday that the central bank will be extremely patient in withdrawing support for the economy after the pandemic ends.
Instead of trying to limit the rise in long-term interest rates, Fed observers expect Powell to use his appearance at a Wall Street Journal webinar to reaffirm the Fed’s determination to meet its revised employment and inflation targets, while maintaining weaker monetary policy for longer and it is clear that he would like to avoid a repeat of last week’s messy bond market.
“It’s not a matter of trying to make ends meet,” said JPMorgan Chase & Co. chief economist Michael Feroli. “But you want interest rates to be aligned with the Fed’s targets.”
This is important for the long-term health of the economy. If the markets and the Fed are synchronized, they will work together to meet the central bank’s targets of maximum employment and average inflation of 2% in its new strategic framework.
Long-term interest rates have risen this year – the 10-year Treasury yield was 1.48% at 4:50 p.m. in New York on Wednesday, up from less than 1% in early 2021 – as a wider release of vaccines to fight the virus and the promise of increased government spending have led to expectations of much faster economic growth.
Patient Brainard
In what could be a preview of Powell’s remarks, Governor Lael Brainard stressed on Tuesday how far the Fed is from meeting its targets.
“We have quite a long way to go,” she said said a webinar of the Council on External Relations. “It’s okay to be patient.”
Brainard said the speed of last week’s moves in the bond market “caught my eye”, adding that she would be concerned if she saw disorderly trading or a persistent tightening of financial conditions, which could slow progress towards Fed targets.
In a congressional hearing on February 23 and 24, Powell eased concerns that rising yields would hurt the economy, saying at one point they were a “statement of confidence” in the future.
Read more: “Man, go back to the office”: the week that shattered bond markets
Markets exploded the next day, with a 10-year treasury yield falling sharply to 1.6%.
Investors have also raised their expectations for the Fed’s first rate hike by early 2023, as they have begun to question the central bank’s commitment to maintaining a light policy until inflation exceeds 2%.
“At the beginning of 2023, it seems to me quite early,” said Goldman Sachs chief economist Jan Hatzius, who does not expect growth until 2024.
PGIM’s chief fixed-income economist Nathan Sheets said this would not be the last time the Fed faces escalating long-term interest rates. He sees a 10-year yield increase to 2% in the summer, before declining by the end of the year.
The Fed has a variety of ways to push back against a period of profitability if it sees the need to do so.
Clock: Danielle DiMartino Booth, CEO of Quill Intelligence, discusses last week’s chaotic Treasury sale, the outlook for the economy and Fed policy.
Guidance Lite
More words will come first. Call it forward lite guidance.
The central bank currently buys $ 120 billion in assets per month – $ 80 billion in government securities and $ 40 billion in mortgage guarantees – and is committed to maintaining that pace “until substantial progress is made.” its objectives.
To help anchor yields, policy makers could become more explicit about when they will start reducing purchases. Fed Vice President Richard Clarida took a step in that direction last week, suggesting that the current pace of buying would be appropriate for the rest of 2021.
Political decision-makers could also be more definitive about what would be needed to raise interest rates. They said they will keep rates close to zero until the labor market reaches maximum employment and inflation has risen to 2% and is about to moderately exceed this level for some time. But these thresholds are somewhat amorphous and open to interpretation.
After the words, the action would come. The Fed could intensify its bond-buying program or transfer mortgage-backed securities purchases to the treasury.
Operation Twist
Another option: a repeat of the Twist operation, in which the Fed removes its holdings of government treasury securities and puts the money in older securities. This would have the added benefit of easing downward pressure on bill rates, which threatens to turn negative.
The Fed could also imitate its Australian counterpart and take control of the yield curve, trying to limit short-term Treasury yields – a strategy Brainard has talked about approvingly in the past.
Wrightson ICAP LLC chief economist Lou Crandall said Powell needs to be careful about rejecting interest rate expectations in the Treasury market. The Fed’s next summary of economic projections, which will be released after the March 16-17 political meeting, could show a growing number of policy makers creating a rate hike in 2023.
Powell could instead highlight the Fed’s new modus operandi for monetary policy in the framework adopted last year.
“He can try to focus market attention on how much regime change has taken place in the Fed’s thinking,” Crandall said.
– With the assistance of Craig Torres