The Powell Party

There are few other events on this planet that attract so much media speculation and attention. No not the Oscars or the Royal wedding.

I am talking of the Fed press conference.

This is where Jerome Powell calmly reveals fed policy to a gaggle of reporters on matters economic (or to be more precise, matters monetary). Fed pundits parse through each word of the press release, each number in the Summary of Economic Projections (“SEP”) and each word uttered by Lord Powell at the press conference.

It reminds me strongly of a stern high priest emerging from the inner sanctum of the deity and talking cryptically to throngs of the faithful.  The latest version of this ritual happened last Wednesday afternoon in New York.

I have devoted nearly six years of my life trying to master the tough and ancient craft of deciphering FedSpeak (it’s a constant learning). So, what exactly did he say (or imply) that I found to be significant?

The Sunshine Reserve

Except for a marginal 0.1% dip in the median long term GDP forecast, the forecasts for unemployment and inflation are exactly the same as back in December 2019. For the Fed to stick to its long-term forecasts shows stubborn optimism.

This is not a mere number matching exercise. The biggest threat that can blast the US economy are the twin barrels of long-term unemployment and massive insolvencies of small and medium businesses. Because if people are unemployed for longer their skills become outdated and businesses are less likely to hire them and that will slash consumer spending. If businesses go under, that will hammer investment and jobs and also the economy.

The Fed's projections – or dot-plot – foresees an unemployment rate of 9.3% by year-end 2020. While that is gruesome, it is far lower than the current 13.3% – and more psychologically significant – in single digits. Interpretation- the Fed thinks the worst is over for the labor market which hence hit bottom in May 2020.

I don't think the Fed expects a second wave of infections and the consequences although many US states are now seeing rapidly rising infections post easing.

Winston Churchill was a stubborn optimist in WWII. Churchill & Co won. Let’s see if Powell wins.

Local hero

It’s very tempting for the Fed to take the foot off the pedal.

We are seeing some positive signs in the economy. There are increases in mobility with encouraging signs of normalization in travel patterns. American Airlines announced that it plans to fly 55% of its regular domestic schedule in July, up sharply from just 20% in May. There are signs of economic stabilization. The latest jobs data is the most high-profile indication yet that the US economy has started to recover.  And of course, every man and his dog know of the rapidly upwardly mobile (and weirdly disconnected) stock market.

But Powell was clear in the press conference.

One of the Fed’s three goals is maximum employment and with 25 million unemployed that’s critical and has to be managed irrespective of how well Wall Street is doing. The Fed is not going to hold back just because asset prices are sky high. Which brings me to……

Party Time!

Congratulations! You are now at the roaring 2020 Fed party.

Take one huge glass of Fed stimulus. Quaff it in one gulp. Run back to friendly bartender Powell who solemnly promises you an endless supply of hooch at an absurdly low rate. The aforesaid bartender also declares that the low rates will stay low till at least 2022. He then smiles and winks at you meaning this cheap stuff is likely to be widely available even after 2022. You laugh and excitedly call your many friends.

Just how big will the party be? How long do you think the party will last? No idea.

But you are probably looking at a long horizon for investors to favor stocks over fixed income, much like the QE driven bull run that followed the GFC.

And don’t worry about the hangover and the cleanup- someone else will worry about all that, including the obscenely high Federal debt build up.

Stay positive

Lord Powell: “Monetary policy is well positioned”. (Overheard at the press conference).

My translation- “No we have no plan to dive down into negative interest rates because it’s unnecessary and unhelpful and also because this policy hasn’t really worked anywhere else and for the Nth time please stop asking me this stupid question”.

Control your curves

Powell was mum on yield curve control (“YCC”) saying that they are “studying the issue”. There was recent speculation whether the Fed will embrace YCC.

What sparked this debate was the US bond yields spike this month. Because the higher probability of a faster economic recovery has driven a flow of capital into risky stocks and away from defensive, low yielding assets like bonds. The US 10-year yield rose from 0.65% at the start of June to 0.82% now.

YCC would see the Fed cap bond yields by buying bonds (bond prices and yields are inversely related). YCC is a way of being clearer that low rates will remain low until either a specific date or when certain economic thresholds are met.

Possible impacts?

Well any commitment by the Fed to YCC will compress the spread between US bonds and, say, German and UK bond yields and also make US treasuries and the US dollar less attractive. Also, if the Fed indulges in YCC, medium and/or long-term rates will go down and the stratospheric stock valuations will make more sense because of the low discount rates and the low borrowing costs.

Watch this space.

Humble pie

The inflation target is still 2% despite Powell confessing in the press conference that not once during the 108-month long expansion did the US hit the 2% target. Not even with historically low unemployment rates and decent economic growth. He admitted the need to be humble and admit ignorance.

Now that we are officially in a deep recession with sky high unemployment, sticking to the same 2% target is downright asinine.

I think I know why. The specter of inflation is always good to juice up spending and economic growth. But the Fed must realize that its credibility on the inflation front was blown cleanly out of the water long ago.

Big issues

Then there are the big complex issues of an economy awash with fiat money, steadily falling productivity, growing income and wealth inequality, the massive fiscal deficit etc.

But the Fed is very much in firefighting mode. And when you are trying hard to douse the flames you don’t think about rebuilding the home. So, don’t expect anything strategic to happen soon. The can will be kicked down the road till the next time someone asks when it will again be kicked further down.

As one of my favorite rockers sang long ago, the show must go on.