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Fed Policy Control Parameters

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How to read Fed chair election? While trying to create a foresighted atmosphere regarding inflation and the Central Bank outlook, especially the Fed; The re-nomination of Fed chair Jerome Powell—a relatively less dovish election compared to Lael Brainard (who was elected vice-president)—was primarily a preference for stability and independence. For the Fed, it is very important to operate an independent decision mechanism that does not cause shocks in the market. Therefore, there is a need for a Fed that is critically positioned and correctly structured in the fight against inflation, rather than a Fed under the control of the Democratic government.

 

Powell inflation perspective… It seems that the word “temporary” has lost its validity in Powell’s current inflation perspective. Thus, it seems that the assessment of his being a “less dove” choice is based on concrete facts:

 

“Challenges and opportunities remain as always. The unprecedented reopening of the economy with the continued effects of the pandemic has led to supply and demand imbalances, bottlenecks and an inflation boom. We will use our tools to support both the economy and a strong labor market and prevent higher inflation from settling. Other key priorities include: carefully maintaining the resilience and stability of the financial system, addressing the evolving risks from climate change and cyberattacks, and facilitating the modernization of the payment system while protecting consumers.”

 

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Within the framework of the understanding that prioritizes the fight against inflation, the fact that the Fed’s administration no longer clings to its “temporary” promise reveals its desire to move forward for policy transformation.

 

Brainard’s perspective… If we look at the perspective of Brainard, who is shy about increasing interest rates;

 

“I am determined to put working Americans at the center of my efforts at the Fed. That means lowering inflation at a time when people are focusing on their own business.”

 

Therefore, it is understood that the event went through both to advance to maximum employment and to reduce inflation. The understanding is: no one is in the point of continuing the reflationist policy by doing business with the rhetoric of “inflation is temporary”. While the economy is advancing, creating demand overheating in an environment where tightness in supply feeds inflation will distract the broad policy from its purpose. Although Brainard agrees with Powell on general issues, she is less aggressive in tightening policy and increasing rates. At this stage, while Covid is still an uncertainty for the economy, it will be necessary to avoid transformations that will move inflation and growth indicators excessively in the opposite direction. Therefore, accelerating or slowing Pursaklar escort down asset purchases is not a stand-alone action criterion; The approach of other central banks to the issue seems to indicate different attitudes about policy speed. Because, while Covid cases are increasing especially in Europe, the new variant has created an uncertainty. However, uncertainty is not only in growth; it is also present in inflation due to supply difficulty and cost constraints. As of November 2021, there is an unprecedented increase in the costs of companies.

 

US 5-year bond yield, 5yr5yr inflation break-even point and 5-10 year bond interest spread. Source: Bloomberg

 

The Fed’s aggressive contraction parameters… Details from November’s FOMC minutes pointed to mixed views on inflation, but hinted that it would be ready to raise rates “earlier than participants currently expect” if warranted by the data. Therefore, the key area for us to watch is how far incoming US data could lead the Fed to a more aggressive contraction. The FOMC began slowing the pace of its securities purchases by $15 billion a month as of this month and will be on track to finish purchases by June 2022. However, policy makers expressed less conviction that the increase in inflation was temporary. The most recent Atlanta Fed President Bostic also expressed an opinion to “reduce asset purchases faster”. If inflation does not soften soon, monetary policy could be tightened more aggressively.

 

Core PCE and risk weighting… Source: Bloomberg

 

Policy control mechanism… There are many examples where the monetary policy ground carried out in an unconventional framework by the fiscal policy authority, apart from institutional targets, is not sustainable and is generally penalized by the markets. Therefore, it is clear that a central bank policy to be advanced under the direction of the government will not be beneficial at the point where the global headwinds are getting stronger. In 1971, inflation rises after Nixon loosened the last remaining bond of the dollar with gold, or the Fed’s aggressively raising interest rates under Paul Volcker and controlling inflation on a policy ground that politicians would not approve of are examples of these conflicts (Jimmy Carter lost the election during this period). After the Lehman Brothers bankruptcy in 2008, the Troubled Asset Relief Program (TARP) was implemented by the US government as an effort to improve its financial position through the purchase of troubled assets held by financial institutions. This, for example, is the most important of the efforts put into practice to eliminate the effects of the 2008 real estate crisis. In the reversal phase of this event, the Fed played an important role and activated its QE programs for a long time. Or in 2012, when European politicians failed to resolve a sovereign debt crisis caused by bad fiscal policy decisions at the national level, the solution was left to the ECB and Draghi. In all these periods, Central banks took important decisions on wealth distribution and determined the direction of money movements. The incentives applied by the Fed during the Covid period also played an important role in this regard. The importance of conventional and institutional policies at the point of protection of financial anchors emerges on the basis of implementation. Global monetary conditions seem to tighten.

 

Conclusion? As we will remember from the Trump era, the Fed moved forward with a focus on institutional goals rather than responding to political status quo expectations. As it will be remembered; Trump, who wanted to move the supply chain into the US, did not want a strong dollar for global competition and was therefore against the Central bank’s rate hike. At the Fed, which was advancing the transformation policy stages from the old QE at that time, Powell turned a deaf ear to these rhetoric. Lowering the interest rates could be the subject of the Covid period, and a perspective change was necessary due to the sudden collapse of the epidemic. Now, it is necessary to determine an up-to-date perspective on inflation, again in the transformation phase of the economy from the crisis. Regarding the Fed’s election for the new term president, it is understood that Biden preferred “stability” during the policy transformation period, rather than the “fresh blood” approach. Of course, it is important how the Fed will control an inflation phenomenon, which has become a social issue and is more closely related to the lower income layer. Ultimately, his political success will also contribute to Biden’s popularity. It is certain that the post-Covid income-eroding inflation phenomenon is not helping at this stage…

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