Fed Chair Jerome Powell worked his magic once again yesterday. Powell’s testimony before the Senate Banking Committee proved to be yet another in a series of catalysts for rallies based upon commentary that soothed traders’ frayed nerves. When a reporter asked me to explain upon the Chairman’s role in yesterday’s buoyant markets, I quipped that the Chairman once again played the role of “Goldilocks in a suit.” He assuaged investors’ concerns that the Fed’s need to address worrisome inflation would not necessarily come at the expense of asset markets. This morning’s CPI release, which was broadly in-line with expectations[i], did nothing to dent the newly ebullient mood.
But while I’m gratified that my Goldilocks comment seemed to resonate with readers, I have a nagging suspicion that my comparison was inapt. The Chairman wasn’t telling us that the porridge was neither too-hot nor too-cold. Instead he told us that even though it was scalding hot at the moment, it would sufficiently cool soon enough. Furthermore, if it stayed uncomfortably hot for longer than he thought, it wouldn’t really burn our tongues if we tried it anyway. Goldilocks was a benign tester of porridge and beds – at least before her eventual mauling by a trio of bears – not someone forced to safely navigate a treacherous, unpredictable situation.
Instead, it occurred to me that investors have decided that Jerome Powell is a financial version of Captain Chesley Sullenberger. For those who have forgotten the reference, “Sully” became famous for guiding a stricken airplane to a safe landing in the Hudson River. Faced with a set of unexpected, incredibly difficult circumstances – in his case, a commercial airliner with both engines disabled by bird strikes shortly after takeoff – he used his knowledge and training to ultimately bring the plane under his command to a safe landing.
Here’s the problem with that analogy: we have no idea if Mr. Powell will be able to land the market without incident this time around. While it is clear that investors are enamored with the Fed’s response to the Covid crisis in early 2020, the current situation is quite different. Nearly two years ago (gasp -2 years ago!), the Fed was able to utilize a playbook that has worked during previous crises. They cut rates, flooded the system with liquidity via conventional measures and quantitative easing, and instilled calm into a moment of extreme crisis. Over the past 20 months, asset prices, and now consumer prices have soared. The problem now is that the Fed needs to figure out a way to undo what they have wrought. Quite frankly, there isn’t a clear playbook for fighting inflation while protecting asset prices. We know that central bankers can do one or the other, but it not obvious that they can do both simultaneously and without incident. Yesterday traders declared their faith that Powell is unwilling to sacrifice investors for inflation-fighting.
It also appears that investors may have overlooked the circumstances surrounding Mr. Powell’s testimony. President Biden recently re-nominated Powell to serve another term as Fed Chair. That job requires Senate confirmation, and this was one step toward a Senate nod. In other words, this was a job interview. It was an unusual one, not least because it was conducted publicly, but it was a job interview nonetheless. Wouldn’t it be natural for a job seeker to respond to questions in a manner that he believes would satisfy those who control his path to employment? Thus wouldn’t it be reasonable for the Chair to portray his economic outlook and personal abilities in a positive light? I’m not implying that Mr. Powell was anything but truthful in his testimony, but I do believe that he was incentivized to put a positive spin on it. And markets liked that positive spin.
The next FOMC meeting is two weeks from today (January 26th). Between now and then we have a wide range of economic releases, but few that are as eagerly awaited as CPI, PCE or payrolls. At that time we will be in the midst of earnings season, meaning that corporate managements will offer their perceptions about how economic conditions are affecting their current performances and outlooks. Even so, we won’t know whether the Fed Chair is Goldilocks, Sully, or something else entirely for quite some time.
[i] The year-over-year rise in the Consumer Price Index (CPI) was 7.0%, which matched the median estimate of economists. CPI ex-food and energy, aka “the core rate”, rose 5.5% annually, only slightly above the 5.4% estimate.
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