Why Powell Pivoted -- Again!
Ballet Dancers Would Be Envious
There was no surprise in the decision by the Federal Open Markets Committee on Wednesday. Much as anticipated, the FOMC held the Federal Funds Rate and decided to continue the reduction in the central bank’s balance sheet that had begun in the summer of 2022. The surprises were contained in the Committee’s statement released at 2 pm Eastern time regarding future action, and in a major shift in position by Fed Chairman Jerome Powell at his press conference a few minutes later. The FOMC omitted its previous assertion that it would keep increasing interest rates until inflation approached the Fed’s 2% goal. But the statement provided no timing for when rate reductions would occur.
The big shocker came at Powell’s press conference. Recall that just seven weeks earlier, the Chairman had told us on December 13 that the FOMC’s focus had shifted from how much further to hike interest rates, to when and at what pace rates should be lowered. The Fed did not want to overdo the tightening, he suggested, because rate increases that have already occurred could work with a lag and put the economy in an avoidable recession. Markets had come away with the conclusion that rate cuts would begin following the Committee meeting on March 19 - 20.
On Wednesday, Powell said explicitly that Fed officials could not be confident that inflation would come down to the 2% level by the March meeting. In other words, the message has changed. The first rate cut will not occur next month. The FOMC decision, and the Powell message, put a massive damper on financial markets.
The Powell pivot over just a few weeks came even though the inflation data since his previous press conference have been relatively benign. He must have known that the major switch would disappoint equity investors who went on a selling spree even as his press conference was going on. What could explain his change in stance?
Powell had witnessed the prevailing rally in financial assets which he further turbocharged with his comments in December. With various inflation indexes still at levels not giving the central bank confidence that its target will be reached, his colleagues probably convinced him that his dovish position would not help future mitigation efforts. After all, even John Williams, President of the Federal Reserve Bank of New York, considered to be a Powell ally, had been quick to warn on December 15 that a rate cut was not imminent.
A second reason for the Powell shift may have been that the Committee has already started talking about slowing the pace of Quantitative Tightening, i.e., the pace at which the Fed sheds its assets, Powell acknowledged. More such discussions will take place at the March meeting, he indicated. The QT process is performed with banks using their cash reserves to buy the bonds that the Fed sells. When such reserves fell sharply, overnight interest rates shot up in September 2019, forcing the Fed to shift from QT to Quantitative Easing in a hurry. Preventing a recurrence of the episode is a major reason why the discussion about slowing the pace of asset sale will come to the forefront in the next few weeks despite inflation being above target.
As reasons go, the clincher, by far, was the blockbuster jobs report released yesterday of which Powell and his colleagues must have had an early indication. The US economy created 353,000 nonfarm jobs in January, the Bureau of Labor Statistics report showed, compared with the 185,000 that the consensus had anticipated. More important, the annual increase in average hourly earnings accelerated to 4.5% last month from an upwardly revised 4.3% in December. Even with an AI-generated increase in productivity, such rapid wage growth is incompatible with mitigating inflation. The massive job creation and wage hikes would have made it difficult for Powell to justify a rate cut at his press conference on March 20 even if he jumped through hoops.
Despite this being an election year, and with his current term ending in May 2026 and subject to renomination by the next President, will Powell be forced to raise rates as the next move? That was the intriguing question I raised in SriKonomics a couple of weeks ago.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
February 3, 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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