New Fed Chairman, New Problems

    Samuel Rines

    Economics, North America

    U.S. Dollar banknotes are seen in this photo illustration

    The Fed appears willing to allow inflation pressures and growth to head higher without combating them with too many rate hikes.

    Jerome Powell has yet to oversee his first Federal Open Market Committee (FOMC) meeting as the newly minted chair of the Federal Reserve. But he may already have been backed into a corner.

    It is not often that the Federal Reserve’s FOMC minutes pique much interest. Typically, they simply elaborate the Fed’s outlook for policy and the reasoning behind it with little incremental information. That probably should have been the case with the latest minutes, but it was not. Instead, immediately following the release, the dollar, equities and the yield on government bond went on a wild ride.

    The question is why? And does it really matter? The answer is the “Powell Pact”—the awkward deal between the Fed and markets. Powell did not choose to be a part of it, but it is his to own now.

    Some background is useful to understanding precisely what we are talking about here. The Fed has struggled to increase inflation to its 2 percent target sustainably most of the recovery. Oddly, a rather vocal segment of the financial media is declaring the Fed to be behind the curve in staving off a massive, sharp increase in inflation. Those headlines get clicks, but are not grounded in reality.

    Make no mistake, there is inflation pressure, and—over time—it should approach the Fed’s 2 percent  target. But it is not there yet, and it is difficult to understand how sub-2 percent inflation could be “runaway,” requiring more and faster Fed funds interest rate hikes. The argument of rampant inflation does not pass muster.

    So why did the minutes matter? Simply, the details that emerged told markets a couple unexpected things.

    Surprisingly, the minutes were dovish. The FOMC appears to be leaning toward inflation risks being tilted to the downside. One of the more intriguing points was the assessment that a quicker pace of growth in 2018 is only a temporary phenomenon. In other words, 2018 growth is “transitory,” which is Fed speak for ignorable and not something that necessarily needs to be taken into consideration when determining monetary policy.

    Once the market began to digest what this means, longer-term U.S. yields rose, the U.S. dollar rose and equities fell. On the surface, this does not make much sense: s dovish Fed does not have the consequence of a stronger dollar and higher long yields. Since when does that happen?

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