Powell has changed his tone, no game. It’s time to stop panicking.

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Federal Reserve Chairman Jerome Powell.

Al Drago / AFP via Getty Images

Just a week after being nominated for a second term as Federal Reserve chairman, Jerome Powell looked unfamiliar. He said it was time to remove the word “transient” that he and many other officials have long used to describe rising inflation, signaling in testimony to the Senate Banking Committee that the Fed is likely to accelerate the reduction of its emergency bond purchase program. . This suggests that the rate hikes could come sooner than expected.

Wall Street was stunned. Major stock indexes fell, with the S&P 500 down nearly 2% on Tuesday and the Nasdaq down 1.5%, as the 30-year bond yield fell to its lowest level this year.

“This is a very steep pivot for the Fed,” said Krishna Guha, head of global policy and central bank strategy at Evercore ISI. “The eight-month reduction plan was announced just four weeks ago and the [New York] The Fed only started implementing it two weeks ago, and that will fuel the feeling that the likelihood of the Fed making a drastic change in its rate plans is much higher than usual. ”

Two things have changed, but perhaps the panic is overdone.

First, Powell secured the re-appointment that had become increasingly questionable in the days leading up to President Biden’s decision. Progressives in Washington had been pushing for the more accommodating Fed governor Lael Brainard to get the green light, and the perceived delay in President Biden’s announcement fueled speculation he might opt ​​for Brainard over for Powell. Some strategists have speculated for months that if and when Powell was chosen for another four-year term, he would feel less inhibited and quickly get tougher in the face of both hotter and more persistent inflation than ever before. predicts central bankers.

Second, the Omicron variant reminded policymakers and investors that the Covid-19 pandemic is not over. This is another ball of the curve for those forecasting the economy. Except this time, Powell reversed the way he defined the balance of risk. So far, the virus has given officials more reason to worry about economic growth than inflation. Indeed, worried consumers cut back on normal activities and spend less, and many workers are more reluctant to return to work when fear of infection increases. Since the start of the pandemic, Powell has signaled that the Fed has been more concerned with the full employment side of its dual mandate than the price stability side.

But on Tuesday, Powell said inflation has become the biggest concern. “The risk of higher inflation has increased,” he said during the first of two days of testimony on Capitol Hill, discussing the effects of the pandemic on supply chains, shortages and prices. In addition, he recognized that price stability is crucial to return to pre-pandemic labor market conditions, when the unemployment rate was at its lowest in half a century. “In a sense, the risk of persistently high inflation is also a major risk in returning to such a job market,” Powell said.

While Powell’s change is remarkable, maybe now is a good time to take a step back. Powell appeared more hawkish on Tuesday than he has ever been since the Fed began to react aggressively to the pandemic and the closures intended to curb it. But he’s still a dove, albeit a little less, and he still chairs a committee that leans for lax monetary policy.

“The market was caught a bit off guard,” says Roberto Perli, head of global policy at Cornerstone Macro. “But I wouldn’t interpret a big change in monetary policy.”

Consider federal funds futures. Before Omicron’s worries hit the markets last Friday, traders were effectively pricing the first interest rate hike in June 2022. On Friday, expectations were exceeded, with take-off bets approaching September, traders betting that further infections would slow the recovery and give the Fed more room to stay patient. On Tuesday, after Powell’s intervention, federal funds futures showed expectations were back to what they were before Omicron.

“Even after today, the market doesn’t expect a take-off until June,” says Perli. In this sense, the reaction of the stock market seems exaggerated. “I think the market read his words a bit too much,” Perli said of Powell’s testimony.

For Perli, Tuesday does not represent the dramatic pivot that many have interpreted. He says reshaping inflation as something other than “transitory” not only makes sense, but is a smart and gratuitous policy step. After all, inflation has become a concern across Main Street as well as on Wall Street, and Powell’s audience today was a bunch of politicians.

At the same time, Perli notes that Powell’s statements regarding the acceleration of taper planes have been covered. Powell said officials will discuss accelerating the cut at their Dec. 14-15 meeting, and that in itself may be a bid to save more time. He said experts told the Fed that we would learn a bit more about Omicron in about a month; one way to read this is that the mid-December meeting is too early to speed up bond buying cuts.

There are two big things on the horizon that will shape the debate and the outcome of the reduction. The first is this Friday’s jobs report, which is expected to show healthy hires. The keys, however, are whether labor market participation has increased and whether wage inflation has slowed. The November Consumer Price Index will also be released a few days before the next Fed meeting. Survey data released on Tuesday morning showed a further significant rise in consumer inflation expectations, and another month of high inflation will only support the Fed’s growing call to end buying of US bonds. emergency earlier.

Powell’s change of tone is significant. But that does not change the situation. For anything that will change the game materially, the Fed is still waiting.

Write to Lisa Beilfuss at [email protected]

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