Fed – new sound track

No, the change in Fed Chairman Powell’s rhetoric has certainly not been subtle. The impression which tends to emerge is that the USA’s top monetary custodian has altered his opinion by 180 degrees within the space of a mere four weeks. Back in early October, Powell clearly implied that the key-rate level at that point was still “a long way” from being anything like neutral. At the same time, he gave financial markets to understand that the monetary authorities could imagine the fed funds rate climbing above the neutral rate of interest (“we may go past neutral”) (quotations on page 4). The financial markets did not take long to respond to this statement: equity markets rapidly sold off sharply. Trump did not take long to craft a response either, voicing his disapprobation in his characteristic manner. Shortly afterwards, the FOMC Chairman had his change of heart. “Shame upon him who thinks evil upon it,” as the saying goes, but suddenly there was Jay Powell claiming that the Fed’s benchmark interest rate was “just below” neutral, even though the FOMC has not implemented any new rate hikes since October (quotations on page 4). There was simultaneously a fresh message for the financial markets: further key-rate hikes after the 25 basis-point tightening step anticipated for the coming week may come through considerably slower. Some market participants have even construed these comments as meaning that the Fed’s gradual rate-hike cycle could soon be at an end. The sea change in opinion has spawned greater uncertainty on capital markets because market actors are now asking themselves: what is the real state of the US economy?

Yet what could be the reasons for this modulation into a different key? Speculation is doing the rounds in the markets that the Fed’s top policymaking committee may, after all, be setting up a “Powell put“ It should be recalled that financing conditions in the economy have deteriorated of late. At the same time, there can be no doubt that crude-oil prices – and therefore inflation expectations – are trending downwards, causing inflationary pressure to ease. Not least, the Fed could indeed be reacting to the fact that the growth outlook (or perceived growth prospects, at least) has clouded over recently. Or has Dr. Powell, quite simply, taken the US president’s criticism to heart? A last explanation would be that financial markets have just misunderstood the Fed chairman’s drift.

Equity markets, at any rate, rallied furiously in response to the paradigm shift in Jerome Powell’s wording. The “Fed put“ (or, in this case, “Powell put“) is a popular paraphrase for the unofficial rule that the Federal Reserve acts very cautiously in the face of stock-market turbulence. It could be observed under the stewardship of both Greenspan, Bernanke and Yellen that the USA’s top central bankers attach an extremely high degree of importance to financial-market conditions. What is likewise of interest on this score is that the Federal Reserve recently published a financial-stability report for the first time. This report views overall risks as moderate.

At the forthcoming press conference, Fed Chairman Powell will doubtless have to field questions about all these possible explanatory variables, as well as about whether he has allowed himself to succumb to political influence. In the light of this, the question-and-answer session following the publication of the statement and the projections promises to be particularly interesting. Another 25 basis-point key-rate hike will undoubtedly not, per se, surprise market participants: the market-implied likelihood of the fed funds target range shifting upwards by 25 basis points next week is currently hovering at around 70%.

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