Powell: Callejón Sin Salida!

The quandary that the Federal Reserve and its Chairman, Jerome Powell, find themselves in is best described by the Spanish phrase, un callejón sin salida — a blind alley, also known as an impasse. The phrase carries the implication that the entity (or individual) finds itself in the predicament at least partly due to its own failings.

The central bank is getting ready for what should be eventful discussions next Tuesday and Wednesday at the end of which it is expected to announce an increase in the Federal Funds rate of 50 basis points. At his press conference Wednesday afternoon, Powell is expected to signal that there could be similar increases following meetings of the Federal Open Markets Committee in June and July, along with a reduction starting in June in the Fed’s holdings of Treasurys and mortgage-backed securities.

Despite his habitual preference for supporting equity holders, the Chairman will have little flexibility to adopt a dovish stance. The US Bureau of Economic Analysis released data Friday that showed that the Federal Reserve’s favorite inflation measure, the Personal Consumption Expenditure price index, rose by 6.6% in March from a year earlier. This was an acceleration from 6.3% in February, and the fastest increase since January 1982. Also, a week after his press conference next Wednesday, markets will learn if the annual consumer price inflation rate in April exceeded the 8.5% in March, already the fastest since December 1981.

Powell had insisted that inflationary pressures were “transitory”, and his Fed contributed to accelerating prices by boosting the central bank’s balance sheet even after the start of post-covid recovery. US inflation is likely to persist at high levels boosted by elevated energy prices resulting from the Russia - Ukraine war, the surge in food prices, and the rise in rents which has followed the increase in home prices.

New uncertainties include the covid-related lockdown in China that started a few weeks ago in Shanghai, with closures spreading more recently to Beijing. Shanghai is a city of 25 million inhabitants, the country’s financial center, and home to China offices of a number of multinational companies. The lockdowns will likely worsen the global supply bottlenecks and contribute to inflation.

With inflation getting out of control, Powell will soon be forced to slam on the brakes. Expect him to continue to say that the Federal Reserve will be able to engineer a soft landing, with the economy growing at 2%+, and the unemployment rate staying below 4% even as the central bank tightens. Accuracy of such a projection? Probably similar to that of his erstwhile forecast on inflation.

Already, the stock market, which had ignored warnings about accelerating inflation and put excessive faith in the Chairman’s forecasts, has tumbled in anticipation of the Fed moves. The NASDAQ, laden with technology stocks that are especially sensitive to movements in interest rates, fell by 4.2% on Friday and by over 13% during the month. April was the worst month for this index since October 2008. The Dow Jones Industrial Average and the S&P 500 index also had their worst month in a long time.

The yield on 10-year Treasurys, which fell at the start of the week, once again rose to close the week near 3%. Expect selling pressure on both equities and Treasurys to persist as the Fed implements its tightening over the next several months. Higher Treasury yields will likely be followed by similar moves in mortgage rates which, for 30-year obligations, are already well over 5%. A further hit to housing demand from wage earners, and a concomitant deterioration in income distribution, are likely outcomes.

A silver lining for Powell: He waited until just after President Joe Biden nominated him for another term last November before shifting from his expectation of transitory inflation. Powell will probably be confirmed as Chairman by the Senate for another four years in the next few days before the adverse impact of the Fed moves are fully felt by the market and the economy. Expect him to acknowledge sometime after the affirmative Senate vote that the economy may have a rough landing after all!

You thought the Federal Reserve is an independent entity unconcerned about political developments? Well, I have a bridge to sell you!

Dr. Komal Sri-Kumar

President

Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

April 30, 2022

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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