Good Cop, Bad Cop, Fed Version

Articles From: Interactive Brokers
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Chief Strategist

Just yesterday, we posed the following:

It will be fascinating to see if other Fed Governors agree with the Chair that a Fed Funds rate of 2.25-2.5% is indeed neutral when inflation is running well above that level.  Economic luminaries like former Treasury Secretary Robert Summers and the well-respected Mohammed El-Erian certainly disagree. If other voting members disagree with the Chair, that would be unwelcome news indeed.  

Almost like clockwork, San Francisco Fed President Mary Daly said the morning that the Fed’s work on inflation is “nowhere near almost done”. Treasuries reacted almost immediately, with 2-year yields jumping 10 basis points shortly after her comments.  Longer-term yields rose less, with the 10-year moving up “only” 6bp. A Fed that is fighting inflation could cause a recession, fears of which are reflected in the 33 bp inversion between 2’s and 10’s.

As noted above, it seemed very premature for Chairman Powell to assert that the Fed had reached a neutral rate. We also noted yesterday that traders appeared to (or preferred to) ignore the second part of Powell’s answer to the question that stated:  “I think the Committee broadly feels that we need to get policy to at least to a moderately restrictive level.” It wouldn’t be surprising if newly bulled-up stock traders simply heard what they wanted to hear. With stocks only down modestly as I write this, they’re certainly ignoring the bond market’s message. (It could also be a “sell the rumor, buy the news” reaction to Speaker Pelosi’s visit to Taiwan.)

The question that I’m wrestling with now is whether Powell’s “neutral” comment was misspoken or deliberate. It would be understandable if he misspoke. I imagine that even someone that careful and experienced could suffer a verbal miscue in front of a room full of reporters. But his track record consists of few overt misstatements, and those tended to be corrected almost immediately. His answer to the question certainly seemed to imply that he really believed his “neutral” comment.

That would mean that it was deliberate. I guess it’s possible that Mr. Powell really believes that the Fed Funds rate is neutral. I’m not sure how, given the obvious evidence to the contrary, but I suppose he is entitled to his opinion. Besides, it might be a more comforting theory than the alternative, that he deliberately misled a market desperate for good news while leaving it to the other Fed Governors and Presidents to walk back those aggressive comments. 

I’m not sure that I’m comfortable with any of those possibilities. A misguided Fed Chair is not a great thought, nor is one that tells the market what it wants to hear when everyone is listening, then leaves it to his colleagues to follow up with the hard truths.  That would be a huge game of “good cop, bad cop”, with stock and bond markets bearing the brunt.  

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