Do Markets Need Powell's Cheerleading?

Latest Promise: "Not Far" From Rate Cuts!

The US Federal Reserve under Jerome Powell’s leadership has shown repeated tendency to undercut its mandate on inflation by providing dovish messages. When the gentler tone turns out to have adverse consequences, officials abruptly shift stance with no sign that any lesson was learned. It happened with Powell’s “transitory” inflation forecast of 2020 - 2021 accompanied by near-zero interest rates and a doubling of the central bank’s balance sheet. That was reversed with 5 1/2 percentage points of interest rate hikes starting in March 2022 because, Powell told us, the surge in inflation had been “unexpected”. Next, his suggestion last December that rate cuts were near got promptly withdrawn in January.

On Thursday, Powell repeated the practice by telling the Senate Banking Committee that, in the case of the first interest rate cut, “we’re not far from it.” This despite upside surprises in the latest inflation numbers relating to all three major price indexes — Consumer Price index, Producer Price Index, and the Fed’s favorite Personal Consumption Expenditure index. The assertion of a quick rate cut was new — not a repeat of comments he had made during his address or Q&A the previous day at the House Financial Services Committee. Perhaps he found that the markets had not welcomed his House presentation as much as he had hoped, and decided to sweeten the message on Thursday?

SriKonomics has emphasized in past reports (for example, here) that such pivots whipsaw markets, increase investor uncertainty and hinder capital formation. And if the intention is to provide Forward Guidance, such pivots transform guidance into Forward Confusion as was the case with the bond market tantrum last October. Treasury yields surged then on fears that the Fed may delay rate cuts.

Yesterday’s jobs report is a case in point. Viewing the report in the context of the Powell statement at the Senate on Thursday, markets have assumed that the first rate will take place on June 12 at the conclusion of the two-day meeting of the Federal Open Market Committee. However, the jobs data out yesterday present a mixed picture.

While the 275,000 jobs created in February are elevated for this phase of the business cycle, numbers for both December and January were revised down, making the latest jobs number more palatable from an inflation point of view. And while the 0.1% month-on-month increase in average hourly earnings last month is a significant deceleration from the 0.5% rise posted in January, the February number is still 4.3% higher than a year earlier, and is incompatible with the 2% annual inflation target the Fed says it is hoping to achieve.

If there is a negative surprise with the February CPI number to be released next Tuesday, or with the PPI data to be posted on Thursday, expectations of a delay in rate cuts would again return, and the market rally may fizzle out. We will have two more CPI numbers — for March and April — before the FOMC meets in June, which could contain their own surprises. Why hurry to announce quick rate cuts as Powell did on December 13 and March 7 when there is so much uncertainty in the final phase of inflation mitigation? What goal does the Chairman hope to achieve by frequently shifting messages?

All these developments factor into interest rates. In addition to inflation rates for March and April that the FOMC will have before it meets in June, the CPI figure for May will be released a few hours before the FOMC decision on June 12. That date is far enough away to carry risk relating to a variety of potential shocks — the possibility of higher energy prices due to developments in the Middle East, a rise in food prices depending on the evolution of the Russia - Ukraine conflict, or further upward pressure on shipping costs due to events in the Red Sea or the Taiwan Strait.

Geopolitical uncertainties ought to make the Federal Reserve more conscious of, and particularly sensitive to, systemic shocks. These, in turn, would have an impact on various components of the economy including banking, real estate and consumers. If, instead, the Fed relegates the possibility of shocks to the background and insists on providing Forward Guidance, investors who follow the advice will likely be disappointed.

While inflation goes through swings between now and the June FOMC decision, vagaries of Fed policy will themselves contribute to shocks to the system. As we know from September 2008, September 2019 and March 2023, when faced with shocks that are sufficiently large, the central bank buckles and cuts rates repeatedly and / or infuses more liquidity into the system.

We may see some easing due to fear of a cash crunch this very month. Watch for the FOMC statement and the Powell press conference to express concern on March 20 about a repeat of the September 2019 money market crisis and indicating that Quantitative Tightening will be relaxed, i.e., the Fed will put fewer securities back into the market every month. This even with inflation measured by any of the major indexes being above the Fed’s target.

History may not only rhyme but also repeat itself!

Dr. Komal Sri-Kumar

President

Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

March 9, 2024

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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