Blaming an “out of control” Jay Powell for one of the most relaxed tightening cycles in history isn’t as outrageous as some think. It’s all about perception.
Don’t envy Jay Powell for having to be the guy who takes the punch bowl of easy money away. He’ll make markets nervous either way.
And making markets nervous means making politicians nervous. Right or wrong, economic sentiment is tied to voting patterns now.
He needs room to do his job. But when there are other priorities, even the Fed and its storied independence occasionally take a back seat.
After all, we all loved that punch bowl when easy money was flowing. And it didn’t look like the party was out of control.
You can fight the Fed
Despite the spin on a lot of recent reporting, it isn’t unprecedented or even especially outrageous for a president to complain about monetary policy or even make suggestions.
Jimmy Carter knew the tough medicine he wanted when he interviewed Paul Volcker. He deliberately created an opening at the top of the Fed in order to make it happen.
Ronald Reagan rode the tough medicine to victory in 1980 and then started talking rates down and Volcker out.
It wasn’t shocking at the time. Presidential comments were framed more like wishes than commands, scrupulously acknowledging that central bankers are a law unto themselves.
After all, the Fed benefits from the aura of absolute impartiality. They call the economy like they see it, even if it means short-term winners and losers in the marketplace and polling place alike.
That’s their power. Especially in the Greenspan years, that aura became an impenetrable shield. Nobody was supposed to challenge the Fed or try to argue monetary policy off course.
And you definitely did not fight the Fed. At least that’s how the story evolved. But that’s more an admission of market wisdom than natural law.
Everyone’s allowed to criticize the Fed, complain about its decisions, loudly wish that a decision go one way or another. But if you challenge or undermine the Fed’s authority, one way or another you’re going to get crushed.
We don’t “fight the Fed” on Wall Street because they’re bigger than we are. To twist the ancient wisdom, the Fed can remain tough a lot longer than we can remain solvent, so we bend when it moves in order to avoid going bust.
Even in the rare cases when an outsider takes on central bankers and wins (think Soros versus the Bank of England) a weaker authority raises systemic risk. Future return paths get fragile and most of us agree a little stability is nice.
Rand Paul may not like it but a strong Fed makes a less volatile world. Undermining it raises volatility.
Fear of volatility is what’s got the market so riled up now. Everyone’s looking for something to count on. If the Fed’s glide path projections aren’t it, there isn’t a lot of clarity out there.
No pain, no gain
Reagan spent a lot of time early on trying to draw the line.
Ultimately he ended up neither calling for resignations nor endorsing what remain some of the highest interest rates in U.S. history.
It let him play good cop while giving the Fed space to make sure inflation was dead. They both got what they wanted in terms of politics and policy.
Something similar may be playing out now. Trump hates to be the economic tough cop. His image is all about hot hiring environments, access to low-cost capital, easy money.
And the Fed clearly needs to refill the rate gun now while tax stimulus is circulating. There just isn’t a lot it can do from its current position if the economy goes south.
That’s why the rate hikes are coming ahead of inflation. Even if inflation is truly and permanently dead, a sluggish economy can still benefit from a little rate relief now and then.
When that happens, voters will cheer. But in the meantime, you know how it works. Markets need time to appreciate even the disruption of a 0.25% hike on the bottom of the yield curve.
We’ve seen significant churn or outright corrections around each of the quarterly rate hikes this year. This one is no exception.
The yield curve needs to adjust as the Fed reloads. If it doesn’t, that’s an outright recession signal, which markets don’t like.
But that adjustment requires rates at the far end to rise. That’s the dreaded 3% bond yield, which I don’t need to tell you is a myth of the modern market.
There’s nothing magically apocalyptic about 3%. It doesn’t instantly wreck the growth narratives around high-multiple tech stocks or the economy in general.
Bond yields have climbed beyond 6% in living memory without crashing a long-term bull market. But people who’ve forgotten that truth are susceptible to all the chatter about rates being “too high.”
I’d rather have a nice steep curve to keep the banks purring and prove to everyone that the economy isn’t anywhere near the inversion zone.
Of course getting to that point requires longer bonds to sell off. Don’t bonds and stocks historically move in different directions?
Either way, as long as the Fed and the White House move in different directions, we’re not necessarily in a bad place at all.
The economy is strong enough for the Fed to keep doing its quarterly dance, but we’re probably 65% through the tightening cycle now. Another 5-6 rate hikes and the world looks normal again.
At that point, 3% will be the rule up and down the yield curve. Assuming of course that we survive that horrific and absolutely unprecedented scenario as well as previous generations, the economy will be in a pretty good place.
Savers will have options. Banks will make money. When the Fed sees conditions cooling, they’ll be able to cut rates to bring a little heat.
Greenspan did it in the late 1990s. You’re allowed to idle through a few meetings or even shift into reverse before moving forward again.
Everything else is just chatter to soothe voters.
After all, Volcker won Reagan the presidency but then lost him Congress two years later. The Fed gives and the Fed takes away.
