Powell Drops Stocks, Flattens Yield Curve With Talks About Accelerating Fed Taper

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Federal Reserve Chairman Jerome Powell.

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What is transient? Federal Reserve Chairman Jerome Powell admitted on Tuesday that it was not about inflation, and said the central bank would likely consider accelerating its reduction in bond purchases at its next meeting political on December 14 and 15.

What may turn out to be more transient is the impact of the Omicron variant of the Covid-19 virus. At this time, its effect on the pandemic and the economy is unknown. Since the economy’s growth has only been temporarily slowed down by the Delta variant pushes, it’s premature to expect Omicron to impose a worse toll.

In his prepared remarks Before the Senate Banking, Housing and Urban Affairs Committee, released on Monday, Powell admitted that Omicron could pose risks to the Fed’s dual tenure on inflation and jobs. In the first case, the central bank’s target of pushing inflation above its old 2% target for an extended period was easily met, with its preferred measure (the core deflator for consumer spending personal) up 4.1% year-on-year. rate. The supply chain effects, already seen to be abating, could be reversed if the pandemic worsens.

As for the labor market, the question is how close is it to full employment? Concerns over Covid appear to be preventing many people from returning to the workforce, observed Powell, as well as Treasury Secretary Janet Yellen, who also testified before the panel.

Given the widespread reports of more job vacancies than job seekers, this might fit the description of full employment. The latest hint came Tuesday from the Conference Board, whose consumer confidence survey found the so-called labor market differential – the gap between respondents who found jobs easy to find and those who thought they were easy to find jobs. ‘they were hard to find – had hit a record. in November. If Omicron further reduces the supply of workers, the job market could be even tighter, all other things being equal.

Powell told the Senate panel that the Federal Open Market Committee may consider liquidating its asset purchases “maybe a few months earlier” than currently planned. As announced earlier this month, the Fed made its initial cut of $ 15 billion, lowering its monthly purchases to $ 105 billion from $ 120 billion previously. Powell pointed out that these asset purchases by the central bank, although smaller, continue to inject liquidity into the financial system.

Ending its bond purchases is a prerequisite for the Fed to start raising its fed funds rate target from the current 0% to 0.25% range. Following Powell’s remarks, the federal funds futures market has again started discounting at least two 15 basis point rate hikes by December 2022, according to FMC FedWatch. (One basis point is 1/100 of a percentage point.)

The message of less accommodative financial conditions came out clearly from Tuesday’s market action, especially on equities. The


Dow Jones Industrial Average

and the


S&P 500

ended the day down around 2%, while the


Nasdaq composite

fell 1.6%. This was despite a 3.2% jump in


Apple

(ticker: AAPL), the largest component of the S&P 500 and the Nasdaq, thus limiting their losses.

The Treasury market gave an even more direct indication of the Fed’s anticipated rate hikes next year. The yield curve flattened dramatically, with the two-year bond yield rising 4.3 basis points to 0.531% by mid-afternoon, while the 10-year bond yield fell by 5.4 basis points, at 1.445%. As a result, the spread between two-year and 10-year notes narrowed to 91.4 basis points, a nine-month low, according to the Saint-Louis Fed. It remains a positive slope in the yield curve, however, which supports economic conditions, although not as super-stimulating as at the start of this year.

One seemingly puzzling aspect has been the recent weakness of the dollar. The


US dollar index

(DXY) was down 0.3% by mid-afternoon on Tuesday, in stark contrast to the expected foreign exchange market response to higher short-term interest rate expectations devised by the Fed. Market sentiment has been strongly bullish on the greenback, pushing the DXY up 6.7% since mid-year. Thus, the dollar’s action may be more technical than fundamental.

Powell pointed out in his testimony on Tuesday that the FOMC will have further readings on jobs and inflation before its next meeting in a few weeks. Key will be the November jobs report, released Friday morning, which economists predicted will show a sharp increase in the non-farm payroll of 500,000 or more, as well as a drop in the unemployment rate. compared to 4.6% in October.

But only a surprisingly weaker report would likely deter the FOMC from making the faster cut announced by Powell on Tuesday, which was also discussed recently by other Fed officials, including Vice President Richard Clarida. Or a serious aggravation at Omicron which is not evident now.

“Given the consistency of the message on the reduction coming from the Fed in recent weeks, it now looks like it will take a deterioration in the public health situation over the next two weeks to prevent the FOMC from deciding to step up. the pace of the reduction at the next meeting, ”wrote Michael Feroli, chief US economist at JP Morgan, in a client note on Tuesday.

The markets have heard the message loud and clear.

Write to Randall W. Forsyth at randall.forsyth@barrons.com

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