Federal Reserve Board Chairman Jerome Powell occasionally repeats a phrase that goes something like the following: “I’m not even thinking about slowing QE” or “I’m not even thinking about shrinking the Fed’s balance sheet” or “I’m not even thinking about raising interest rates.” In the Q&A portion of his February 10 speech to the Economic Club of New York he managed to work that phrasing in a couple times.
Why? Even as he prepares for this week’s Fed policy meeting, Chairman Powell thinks that he won’t be able to mention changing the Fed’s trajectory until at least February 2022. That’s when his term is up, and he knows that if he hints the Fed may modify the central bank’s ultra-easy monetary policy he may not be reappointed.
Powell and others with their sights set on the Fed Chair position know that they could be cancelled by hinting at something other than full speed ahead with their helicopter money program. The Fed’s balance sheet has increased by $3.4 trillion in the past year and is climbing by approximately $120 billion per month due to combined purchases of Treasury and MBS securities.
Market participants know this, which is why: 1) inflation expectations keep moving higher, 2) the yield curve continues to steepen, and 3) the commodity and cyclical reflation trade continues.
Five-year breakeven inflation expectations at 2.5% are the highest since 2008. The yield curve continues to steepen, a positive for bank earnings going forward. The CRB commodity index appears to be on the verge of breaking out on the upside of its five-year range.
Investors know that Powell appears frozen in place for the next year and won’t say or do anything to alter the course of ultra-easy monetary policy, suggesting that inflation expectations and commodity prices are heading higher.
President Biden is implementing an extreme progressive agenda involving a massive income redistribution policy, and easy money is essential to Biden’s plan. The first phase was to ram through massive Federal spending of $1.9 trillion for households and states in an economy that is already booming.
More Federal outlays are planned, including an infrastructure program and a new Green deal. Team Biden has already created a large Federal deficit and will call for a second phase of huge tax increases to facilitate their income redistribution scheme. An ultra-easy money policy will be needed to help offset the adverse effects of tax increases.
Federal Reserve leaders understand their political marching orders. Capital market interpretation: no change in monetary policy until at least after the Biden team announces the next Fed chair.
The FOMC January 26-27 committee minutes must have been music to the Biden Team:
“In their discussion of the outlook for monetary policy, participants judged that maintaining a highly accommodative stance of policy was essential to foster further economic recovery and to achieve an average inflation rate of 2 percent over time,” the minutes said.
In addition, “All members agreed to maintain the target range for the federal funds rate at 0 to ¼ percent, and they expected that it would be appropriate to maintain this target range until labor market conditions had reached levels consistent with the Committee’s assessments of maximum employment and inflation had risen to 2 percent and was on track to moderately exceed 2 percent for some time.”
Full employment is out, and maximum employment is in. Team Biden’s income redistribution program reduces the incentive to work which means maximum employment likely won’t be met even if we knew what maximum employment meant. The unemployment rate for those 25 and over with less than a HS degree is 10.1% in the February Employment Situation report, while the unemployment rate for those with a college degree is 3.8%.
Team Biden has opened the southern border to a flood of illegal immigrants. The illegals will compete for jobs with Americans that have less than a HS diploma. Biden’s border policy works to increase unemployment in that group. As such, it is not clear that the Fed’s maximum employment goal can ever be met.
Market participants appear to be the only throttle on the Fed’s ultra-easy money policy. Actual inflation, as measured by the personal consumption expenditure deflator, will likely need to climb to at least 2.5% or higher on a sustained basis before the Fed leadership moves to rein in easy money.
In the March Blue Chip Economic Indicators, a widely followed economic forecast, 38 participants had the PCE deflator at 2% or above this year, with the highest at 3.0%. If so, Fed leaders will likely say that this expected 2021 inflation surge is transitory so they can maintain their easy money policy.
The implication: equity and bond prices need to adjust downward to reflect higher inflation ahead.
Mike Cosgrove, principal at Econoclast, a Dallas-based capital markets firm, is a professor at the University of Dallas.
