Looks like the start of a U-Turn on inflation. 2-year and 10-year yields jump.
By Wolf Richter for WOLF STREET.
The White House announced today that President Biden, eager to get something through the Senate without a long bruising fight, will re-nominate Republican Jerome Powell for a second term as chair of the Federal Reserve’s Board of Governors and will elevate Democrat Lael Brainard to vice chair. Powell is opposed by some prominent Senate Democrats, but supported by many Republicans. And Brainard doesn’t seem to face opposition from Democrats. Both will likely win Senate confirmation.
As you would expect, both Powell and Brainard released thank-you statements about their nomination.
But as you would not expect, fighting inflation was suddenly the number one priority in both their statements – after they’d driven inflation to a three-decade high through record gigantic money printing and interest rate repression, and then had stubbornly brushed off this inflation as something that would quickly go away on its own.
There wasn’t a word in their statements about this inflation being “temporary” or “transitory,” and about the Fed needing to be “patient,” and waiting for it to go away on its own. But inflation was suddenly a real problem that needed to be dealt with.
Powell’s first priority is now to “prevent higher inflation from becoming entrenched,” he said:
“The unprecedented reopening of the economy, along with the continuing effects of the pandemic, led to supply and demand imbalances, bottlenecks, and a burst of inflation. We know that high inflation takes a toll on families, especially those less able to meet the higher costs of essentials like food, housing, and transportation. We will use our tools both to support the economy and a strong labor market, and to prevent higher inflation from becoming entrenched,” he wrote in his statement.
“Other key priorities include…,” he said, well, the laundry list you’d expect, from “guarding the resilience and stability of the financial system” on down.
Brainard’s first priority is now “getting inflation down”:
“I am committed to putting working Americans at the center of my efforts at the Federal Reserve. This means getting inflation down at a time when people are focused on their jobs and how far their paychecks will go,” she wrote in her statement.
This looks like the beginning of a U-Turn on inflation.
There are seven positions on the Bord of Governors. One of them is already vacant. One of them opens up at the end of this year. And one of them is likely to open up early next year.
Powell will be chair, Brainard vice chair. Randal Quarles, the chair of the Financial Stability Board, has already announced his resignation effective the end of 2021. Which opens a second slot. And current vice chair Richard Clarida, being replaced by Brainard as vice chair, will likely ride off into the sunset when his term expires in January. This opens a third slot on the seven-member board.
No one knows what the Board of Governors is going to look like next year.
But the meetings that Biden had with Powell and Brainard must have been a hoot, to have this effect of inflation suddenly being elevated to the number one priority.
Did Biden explain to the pair what a bitch inflation had become, that people are getting frustrated and restless and very unhappy as their wage increases plus some are gobbled up by higher prices, that it’s hurting people that live off their labor? Did he say that it was time for Powell and Brainard to get off their high horse and do something about these crazy price increases?
A crackdown on inflation requires a political deal between the Fed and the White House. They have to sing off the same page when they talk to Americans about the fight against inflation. Volcker and Reagan had this down pat early on in Reagan’s first term.
Today, a crackdown on inflation would mean a quicker end to QE. So far, with brazen disregard for inflation, now tracking over 6% as measured by CPI, the Fed has continued its money-printing spree.
It just now reduced the amount of its asset purchases from $120 billion in October, to $105 billion in November and to $90 billion in December. But they’re still printing money! So I expect that asset purchases will end sooner than the previously announced time frame through mid-2022.
A crackdown on inflation would mean that after QE ends, some maturing bonds would be allowed to roll off the balance sheet without replacement, with the effect of shrinking the balance sheet – similar to what the Fed had done from late 2017 through August 2019.
The massively huge wave of QE since March 2020 – $4.4 trillion of money printing in 20 months – pushed down long-term interest rates to record lows and inflated asset prices to record highs, including the housing market, and helped fire up inflation to the highest rates in three decades.
The end of QE and a subsequent reduction in the balance sheet would allow long-term rates to rise and would drain exuberance from the financial markets.
A crackdown on inflation would mean raising short-term rates closer to the level of inflation, and if inflation doesn’t slow down, to raise them above the rate of inflation. So we can do the math on that.
The 2-year Treasury yield jumped 7 basis points today, to 0.59%, the highest since March 2020. The 10-year Treasury yield jumped 8 basis points today to 1.63%.
But the Treasury market is still held down firmly by the ongoing huge QE and the Fed’s gigantic balance sheet. The Fed owns about 25% of all marketable Treasury securities. It has been the relentless bid. It buys no matter what. It buys high. And it doesn’t sell. It’s not trading securities. It’s creating money (credits) and using this money to absorb securities. This has a huge impact on the market. And long-term yields cannot rise significantly until the Fed steps away from the market, stops buying, and then starts unloading its balance sheet.
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