Sweet Surrender

Janet Yellen had a pretty easy job when she was the Federal Reserve chair. By keeping interest rates at or near zero for years on end, she never heard any criticism from the president, government officials or the financial markets. Since he became Fed chair a little over a year ago, Jerome Powell has gotten nothing but flack, from President Trump – who was at it again last week – to a whole swarm of people on Wall Street complaining that the Fed was ruining their returns.

Powell got the message several months ago, and last week he handed in his formal surrender. Not only did the Fed leave interest rates alone at its monetary policy meeting, but it indicated that there would likely be no more rate hikes the rest of this year, and maybe next year, too. “It may be some time before the outlook for jobs and inflation calls clearly for a change in policy,” Powell said.

The Fed also called a halt to the runoff in its still humungous Treasury securities portfolio. Beginning in May, the Fed will slow to $15 billion – from the current $30 billion -- the monthly redemptions of its Treasury holdings, with the runoff to end in October, meaning its balance sheet will start growing again.

So now Powell and his Fed mates can sit back blissfully and listen to the silence, at least for now.

The Fed’s surrender on interest rate and monetary policy follows that of the European Central Bank, which two weeks ago announced that it would keep its main interest rate at minus 0.4% at least through the end of this year – which in all likelihood means next year, too – while announcing a new stimulus plan to get the slumbering eurozone economy off its back through cheap loans to banks.

If you just woke up from a deep sleep, you’d think it was 2011 again, with the global economy still reeling from the global financial crisis. Yet, here we are, more than 10 years removed from that dark time, and we’re still basically in crisis if central bank policy is any indication.

Europe has been a mess for a while now – and a hard Brexit isn’t going to make it any easier – so the ECB arguably needs to do what it needs to do. Why the Fed feels it necessary to follow along and go back to the days of easy money is a little mystifying.

In his comments after last week’s meeting, Powell said: “the U.S. economy is in a good place, and we will use our monetary policy tools to keep it there.” Instead, he justified the Fed’s new do-nothing policy by the supposed lack of inflation, namely the Fed’s failure to achieve 2% inflation, which it considers to be the optimal rate.

How much faith we should put in the Fed’s reading on inflation – and its ability to control it – is open to skepticism. A visit to the supermarket or the doctor’s office, the highway toll booth, and the local tax department, or to pay your child’s college tuition, might indicate that inflation is a lot higher than what the Fed thinks it is.

So where are we now? Since the Fed announced its return to a do-nothing monetary policy, the yield on the benchmark 10-year Treasury note has sunk well below 2.50%, its lowest level since the end of 2017. In Europe, the 10-year German bund, the eurozone benchmark, has dropped into negative territory, the first time that’s happened since October 2016.

Not surprisingly, bank stocks have been in freefall, since super low rates – never mind negative ones – make it a lot harder for them to make money, which also bodes ill for the economy at large.

It’s not clear why the Fed is acting like it’s 2011 again if Powell is also proclaiming that the economy is in a “good place.” If he truly believes that, inflation will take care of itself, as it always has, and no amount of financial engineering by the Fed is going to change that. We know that since the Fed and its counterparts at the ECB and the Bank of Japan have been trying to raise inflation for the past decade without success. And what harm has low inflation actually caused anyone anyway?

While doing nothing is certainly the easy thing to do and avoids criticism, that doesn’t mean it’s the wisest monetary policy. While pausing on interest rate increases seems sensible following the recent lull in economic growth, the Fed shouldn’t be promising such a policy for “some time” if the economy suddenly reverts back to 3% growth. Then Powell will have to pull another sharp policy reversal back to normalizing rates again, which will open him up to even more criticism for being so wishy-washy. And he’ll deserve it.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

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