Treasury Secretary Yellen's Gaffe

You kind of knew this was going to happen eventually. You’re just probably surprised it happened so fast and so publicly.

After serving as Federal Reserve chair for four years, until February 2018, and now Treasury Secretary since January, Janet Yellen could probably be forgiven for forgetting what position she holds. After all, in addition to being located in Washington, both the Fed and the Treasury pretty much work hand in hand, with the former directing monetary policy and the latter handling fiscal policy. Under the pretense, they’re both independent of each other.

But last week, Yellen let the cat out of the bag and ignited a one-day mini taper tantrum in stock prices, which is a little hard to understand, given that she only said what everyone else was already thinking. (But as we know, a gaffe is when a politician or government official accidentally tells the truth).

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending [proposed and already enacted by the Biden Administration] is relatively small relative to the size of the economy,” she said in a prerecorded interview at the Atlantic’s Future Economy Summit.

Later on, of course, she walked that back a little, telling the Wall Street Journal, “I don’t think there’s going to be an inflationary problem, but if there is, the Fed can be counted on to address it,” she said.

It was certainly much ado about nothing, but it raises an important question, namely: Other than raising interest rates, either directly or indirectly, what exactly can the Fed do to fend off higher inflation? Continue reading "Treasury Secretary Yellen's Gaffe"

Be Careful What You Wish For

Remember when over the past four years, we were warned repeatedly about the dangers of “politicizing” the Federal Reserve? Well, apparently, that had nothing to do with politics per se, just which side was doing the politicizing. Now that a different party is pushing the Fed in another direction, we don’t hear much about the dangers of politicizing the Fed anymore.

Indeed, an op-ed in the Financial Times goes one step further, arguing that the Fed – and central banks in general – should not only be above politics but allowed to dictate the rules for us mere mortals by executive fiat. And what issue is so important that it can’t be left to our elected representatives to decide what to do? Well, climate change, of course.

“We are facing a climate emergency that demands collective action, and central banks must undergo another transformation, perhaps an uncomfortable one, to play their part in dealing with it,” the author writes. “By reshaping their interventions in asset markets, they can accelerate reductions in carbon emissions and change the cost of capital to address hidden climate risks in the financial system.”

“The magnitude of the physical risks associated with climate change means central banks need to use their full suite of powers to help the transition towards a low-carbon world. And one of their tools is speed,” the writer continues. “Rather than waiting for governments to agree on legislation, investment programs or carbon taxes, central banks can act now to reflect better the cost of climate change in the cost of capital and to change the behavior of businesses, increasing it for emitters and lowering it for investment in carbon reduction (emphasis mine).”

In other words, who needs laws when the Fed can just order us around? Continue reading "Be Careful What You Wish For"

Are You Ready For Some Inflation?

The latest indicators of inflation are in, and they’re starting to look a little warm – bad news if you’re a bond investor. For March, the consumer and producer price indexes showed prices rising at their highest levels in years and well above the Federal Reserve’s 2% target.

The headline consumer price index jumped 2.6% on a year-on-year basis, the most since August 2018, and 0.6% since February, the biggest one-month jump since 2012. A good part of that rise was due to the steep rise in gasoline prices, so the so-called core CPI, which excludes food and energy prices, showed a more modest 1.6% YOY rise.

The producer price index, however, showed inflation running even hotter. Headline PPI jumped 4.2% YOY in March – its biggest spike in nearly 10 years – and a full 1.0% compared to the prior month. Excluding food and energy, the YOY increase was 3.1%, 0.6% on a monthly basis. Producer price increases often – but not always – turn into higher consumer prices, depending on whether or not manufacturers choose to, or are able to, pass along their higher costs to customers.

Whether these are momentary spikes or not, of course, remains to be seen. For his part, Fed chair Jerome Powell professes not to worry. Continue reading "Are You Ready For Some Inflation?"

Did The Fed Just Send A Message?

In case you missed it, last Friday, the Federal Reserve agreed to let a year-long suspension of capital requirements for big banks that allowed them to exclude Treasury securities and deposits held at the Fed from their supplementary leverage ratio expire at the end of the month.

While the subject of bank capital ratios usually puts some people to sleep, the Fed decision could have very real consequences for the financial markets and the nascent economic rebound at large. It also seems to diverge from the Fed’s own stated and oft-repeated monetary policies.

Then again, the Fed may have just sent a subtle message that its low-rate stance is about to change.

As the New York Times explained, the intention of relaxing the banks’ capital requirements last year at the outset of the pandemic-induced economic lockdown “was to make it easier for financial institutions to absorb government bonds and reserves and still continue lending. Otherwise, banks might have stopped such activities to avoid increasing their assets and hitting the leverage cap, which would mean raising capital. But it also lowered bank capital requirements, which drew criticism.”

At a practical level, Friday’s decision may add further fuel to the fire that is driving up bond yields by discouraging banks from buying Treasury securities, which would seem to run counter to the Fed’s low-interest-rate policy. The Fed, of course, is buying trillions of dollars of Treasury and mortgage-backed securities, which it has stated it has no intention of stopping. Yet, it saw fit to make a move that could have the effect of driving the banks – also big buyers of government securities – out of the market. So why did the Fed do this? Continue reading "Did The Fed Just Send A Message?"

Which Way Will The Fed Blow?

Let’s see if I have this straight. For the past dozen years or so, dating back to the 2008 financial crisis, the Federal Reserve and other major central banks have been trying to raise inflation and thereby generate economic growth. (I’ve never quite understood that thinking; I always thought economic growth generated inflation, not the other way around. But that’s just me.)

So now it finally appears that inflation is about to rear its head, or so the bond market thinks, on the prospects of a nascent economic boom fueled by pent-up demand, fiscal stimulus, a decline in Covid-19 cases, and a vast rollout of vaccines. And what is the market’s reaction? Total panic. Sell bonds and tech stocks that have soared during the pandemic. And beg Jerome Powell and the Fed to save them from losses once again.

Let’s see which Powell responds—the one who has told us over and over again that the Fed will be “patient” and be pleased to let inflation run hotter and longer if it means boosting the employment market; or the one who repeatedly rides to the rescue whenever investors start to lose money and beg for relief.

On the surface, it should be the first one. Over the past month or so, bond yields have risen sharply on fears of rising inflation. Rather than a cause for worry, this should please Powell and the rest of the Fed. After all, they’ve been preaching for months that this is what they want, so this should come as no surprise to anyone. Plus, it’s a good thing – rising rates signal economic growth. Yet, the market’s reaction is shock and dismay. Continue reading "Which Way Will The Fed Blow?"