There were times in the past when Federal Reserve Chairman Jerome Powell could act as if he was Master of the Monetary Policy Universe. Having increased interest rates several times during 2018, he announced on December 19 that more rate increases would follow next year. As markets cratered in the final days of 2018, the Federal Reserve cut rates repeatedly in 2019. Increasing the Federal Funds rate by 75 basis points in June 2022 for the first time since 1994, he suggested that such a big increase would not become the norm. Three more similar rate hikes followed before the year ended.
Justifying near-zero interest rates and doubling the central bank’s balance sheet in 2020 - 2021 despite an economic recovery, he told us the measures were justified because the pickup in inflation was “transitory.” Consumer prices rose by 9.1% in June 2022, the fastest since November 1981. Not one to admit error in judgment, Powell simply declared that the acceleration in inflation had been “unexpected”. On the other hand, officials of Silicon Valley Bank who believed the Chairman’s “transitory” forecast and bought long-dated Treasurys lost their jobs and had to shut the bank down last March.
Powell’s luncheon talk at the Economic Club of New York on Thursday was in sharp contrast to his past statements as head of the world’s most powerful central bank. Unlike earlier speeches when he had seemed so certain about where interest rates and inflation were headed — sometimes wrong but never in doubt — he seemed unsure as to what to do next.
Specifically, he ruled out the possibility that expectations about inflation or about the next few moves by the Federal Reserve were behind the recent volatility in bond markets. Instead, it was the role played by rising term premiums — the additional yield that investors demand for purchasing longer-dated securities. Since term premium is a theoretical concept not measurable in practice, the Chairman could justifiably claim that he could not anticipate the Fed’s next moves.
What may have put him in this uncertain state is the sharp run up in long-dated Treasury yields that the Federal Reserve had simply not anticipated. Other than a reference to higher bond yields tightening credit conditions, his prepared remarks made no mention of the turbulence in Treasurys, even though that development was at the top of investors’ minds.
The yield on 10-year Treasurys touched 5% on Thursday, rising from 4.36% on September 18. What caused the 64 basis-point surge in a month? The Chairman did not — more likely, could not — say. If a widening term premium had resulted in the rise in yield, what was the cause of the wider premium? He could not just blame it on the new war in the Middle East because the conflict also gave rise to a safe haven rush into dollars and long-dated Treasurys.
But he felt sufficiently secure to assert, in answering questions from Bloomberg’s David Westin, that higher bond yields were doing the job of the Fed in tightening credit conditions and setting the stage for a reduction in inflation. He virtually assured listeners that there will be no increase in interest rates on November 1 following the next Federal Open Markets Committee meeting. Does that also mean that the Fed does not have to tighten policy at subsequent meetings? Or, in his own words, “Does that [higher bond yields] mean that policy is too tight right now? I would have to say no.”
We would all like to have the cake and eat it too, Mr. Chairman. But few of us get the opportunity to speak from both sides of the mouth!
Conflicting statements — that higher Treasury yields had resulted in tighter credit conditions but have not prevented the economy from growing at a rapid pace — contributed to a volatile market for both equities and bonds Thursday afternoon. Markets rallied as Powell suggested a cautious approach to rate setting in coming months, and then fell back as he stressed that he was not ruling out future rate hikes.
Although the yield on 10-year Treasurys fell back to 4.91% by the end of yesterday’s trading, all three major equity indexes took a hit Friday. While the Dow Jones and S&P 500 indexes fell by about 1% each, the most interest rate-sensitive index, NASDAQ, fell by over 1.5%. Clearly, the Powell talk on Thursday had done little to calm markets following 10 days of bond market turmoil.
Elevated Treasury yields, combined with lack of clarity even within the Fed regarding its next steps, could increase the chances of a “credit event” that has been a frequent topic of discussion in SriKonomics issues.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
October 21, 2023
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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