When Jerome Powell took the reins of the Federal Reserve in 2018, it seemed as if the era of dovish monetary policy was at an end. An outspoken policy hawk, Powell was one of the harshest public critics of the Fed’s then-Chair Janet Yellen. Yet, as I have discussed previously, Powell underwent a rather remarkable transformation in the months following his ascension to the chairmanship in response to unprecedented political pressure from President Donald Trump. Having already been cajoled into a more dovish posture, the outbreak of the coronavirus pandemic pushed Powell to increase Fed interventions to historic levels.
With the economic disruptions wrought by the pandemic beginning to fade, the Fed decided it was safe to start thinking about a slow return to normalcy. Anxiety remains high at the central bank, however, as evidenced by the Federal Open Market Committee’s July statement.
Inflation is back with a vengeance
Having managed at long last to rejuvenate inflation in the U.S. financial system, as I discussed last week, the Federal Reserve now faces another challenge: preventing a normal inflationary environment from spiraling out of control. Powell acknowledged the issue in his July 15 testimony before the Senate Banking Committee:
“This is a shock going through the system associated with reopening of the economy, and it has driven inflation well above 2%. And of course we’re not comfortable with that...We’ve identified a half dozen things [that] look very much like temporary factors that will abate over time. What we don’t know is are there other things coming along to replace them?”
Powell is hardly alone in his anxieties. Indeed, a number of other senior Fed officials have sounded the alarm in recent weeks and months. In May, for example, Vice Chair Randal Quarles openly questioned the wisdom of continuing the Fed’s asset purchasing program:
“If my expectations about economic growth, employment, and inflation over the coming months are borne out, it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings.”
The Fed has made no secret of its inflation control worries in its recent communications, and officials have warned that a case of transitory high inflation could end up persisting longer than expected. Powell sought to assuage public anxiety over inflation in his July 28 remarks, stating that the Fed will intervene to curb inflation if it “persistently, materially remains above goal.”
No tapering anytime soon
Clearly, the Fed’s leaders understand that a policy of endless monetary looseness and bond market intervention is not sustainable. Yet the FOMC’s statement for July appeared to walk back its recent comments concerning policy normalization. In fact, the Fed announced the creation of two permanent repurchasing agreement facilities, as Bloomberg reported on July 28:
“The two standing facilities -- domestic and foreign -- will serve as backstops in money markets, the central bank said in a statement. The decision to create the facilities follows several years of discussion within the market about whether they are needed and what form they might take. The Fed already has temporary repo facilities in place.”
The establishment of these new repo facilities is a fairly unambiguous signal that the Fed intends to continue its direct intervention for the foreseeable future despite the many signs of rising inflation and strengthening economic growth.
The Fed’s anxiety about winding down its market support efforts is understandable, given its past experience. In 2013, when the Fed tried to gradually reduce the quantitative easing put in place to combat the Great Financial Crisis, the market reacted violently in what was soon dubbed the "Taper Tantrum" by observers. Evidently, the current Fed leadership is leery of causing a similar reaction under current market conditions.
Keeping the music playing
As the central bank of the world’s largest economy, the Federal Reserve is rightly listed among the most powerful global financial institutions. Its responsibility for, and power over, the world’s reserve currency adds even more weight to its policy decisions. When the Fed acts, it sends ripples across markets and economies worldwide.
Thus, whenever the Fed shows a sign of policy listlessness or uncertainty, no matter how faint, investors tend to pay attention. As I see the current monetary policy situation, the Fed has little intention of reversing its dovish stance anytime soon. That was made abundantly clear in the FOMC’s statement for July, as well as by Powell’s subsequent comments, which included a defense of the current Fed framework when asked whether falling bond yields were indicative of falling confidence in his institution.
In sum, I see the Fed’s latest statements to mean that dovish monetary policy is here to stay. Yet, while the Fed can delay policy normalization, it cannot prevent it. The dangers of runaway inflation and financial crisis are well understood. Consequently, my advice to investors is to move with caution.
