The momentous, mysterious monetary U-turn by Federal Reserve Chairman Jerome Powell and his colleagues this week has spawned a host of conspiracy theories as to what’s really going on at the world’s most powerful central bank.
They range from the simple -– the Fed is capitulating to the demands of the financial markets and/or President Donald Trump for a halt in interest rate hikes -– to the more subtle: There’s been a policy regime change at the central bank and it’s now deliberately seeking to push inflation above its 2 percent target.
Other possibilities range from the timeworn -– Powell knows something scary about the world economy, of which investors are blissfully unaware -– to the more timely: He has a penchant for wrong-footing financial markets, in both directions.
Just six weeks after saying it was on course for “some further gradual increases’’ in rates, the Fed signaled on Wednesday that it was done tightening for now, and left open the possibility that its next move might be a cut. And it did so even though it still believes 2019 will see solid economic growth, a strong jobs market and inflation near its goal.
Powell sought to explain the Fed’s pivot by pointing to a panoply of risks: slowing global growth, tighter financial conditions, and various geopolitical fault-lines, including Brexit and U.S.-China trade tensions.
The trouble with that account is that all those risks were already in evidence in December, when the Fed hiked rates for the fourth time in 2018 and penciled in two more for this year.
Market professionals have spotted an explanatory vacuum, and they’re rushing to fill it. Here are some of the premises making the rounds:
Proponents of this one say the Fed under Powell is just operating the way it did under previous chairs dating back to Alan Greenspan. When the stock market nosedives -– as it did after the Fed’s December meeting — the central bank can be counted on to support equities by shifting to easier money. Societe Generale SA’s Omair Sharif described this week’s statement as “a letter of apology’’ to the markets.
Powell told reporters Wednesday that the Fed does take account of sustained changes in financial conditions when setting policy, because they impact the economy. But he said the focus is on a range of markets, not just stocks.
Powell did capitulate on Wednesday, this theory agrees — not to the markets but to the tweeter-in-chief, who’s repeatedly attacked the Fed. Cornerstone Macro LLC partner Roberto Perli said he’s heard clients espousing that view, though he doesn’t buy it.
Powell addressed this issue in his press conference. “We’re never going to take political considerations into account or discuss them as part of our work,’’ he said.
This is perhaps the most intriguing conjecture. Proponents, including JPMorgan Chase & Co. chief U.S. economist Michael Feroli, argue that the Fed now views an inflation overshoot of its 2 percent goal as a “desired outcome.’’ That would be a big departure from previous Fed chairs, including Powell’s predecessor Janet Yellen. As part of this shift, “Powell is doing his best to bury’’ the Phillips Curve concept that central bankers have hewed to for years, which ties changes in inflation to job-market developments, Feroli said.
Shooting for inflation above -– but not too far above -– target could help cement critical inflation expectations at 2 percent after years in which price rises fell short of that level. It might also dovetail with the wide-ranging public review of the Fed’s practices that policy makers have teed up for this year.
There’s just one problem. It’s hard to tease out such an historic change from what Powell said on Wednesday. The only hint was this comment from the chairman, coming at a time when core inflation stands at 1.9 percent. “I would want to see a need for further rate increases, and for me, a big part of that would be inflation,’’ he said.
Did the Fed abruptly turn dovish because it knows that the global economy, particularly China’s, is in much worse shape than is widely realized? Judging by the run-up in stock prices after the Fed meeting, few investors believe this.
That’s just as well, according to PGIM Fixed Income Chief Economist Nathan Sheets. “I’d be very surprised if the Fed had some information about China or Europe that isn’t already in the ether of the markets,’’ said Sheets, who spent 18 years at the central bank.
This is the sobriquet Bank of England Governor Mark Carney earned in 2014 for giving what were seen as conflicting signals on monetary policy. And it’s one that some Fed watchers are now ascribing to Powell after his comments have yanked markets around in recent months.
“Fed communication policy is in tatters,’’ said Michael Gapen, chief U.S. economist at Barclays Plc, in a Jan. 30 note. “We worry that the Fed has traded near-term support for financial markets and the economy for another round of volatility later this year if it is forced to lift rates.’’