Powell’s congressional testimony displays commitment to threading-the-needle between goal attainment and overheating

Rick Rieder

Rick Rieder, BlackRock’s Chief Investment Officer of Global Fixed Income, regarding FOMC Chair Powell’s testimony before the U.S. Congress.

Since the late-1970s, when Congress mandated that the Federal Reserve provide it with semiannual updates on the state of the economy and monetary policy, market observers have scrutinized those remarks to try to discern the future direction of policy.

Not surprisingly, this exercise has often provided little new insight, as the Chair’s prepared remarks and answers to questions typically have hewn closely to previous statements.

As a case in point, Powell delivered a fairly upbeat message on the progress of labor market gains and on economic growth, which reflected the upgraded optimism portrayed in the recent FOMC Minutes language.

Further, his remarks suggested that he remained unperturbed about the below-target inflation levels of recent times, saying that it likely reflects “transitory influences,” which are not likely to be repeated.

As a result, Powell argued that certain economic developments that have taken hold since the Committee’s December meeting (such as passage of the tax cuts and the recent budget plan), as well as continued solid organic economic growth (both in the U.S. and around the world), make a strong case for a gradual continuation of policy normalization.

When asked explicitly whether this more stimulative fiscal policy might cause the Fed to move rates more quickly than previously anticipated, Powell responded by saying that: “My personal outlook for the economy has strengthened since December.

Each member of the FOMC is going to be writing down a new set of projections as we go into the March meeting, which begins in less than three weeks.

I would not want to prejudge that new set but we will be taking into account everything that has happened.”

Clearly, in our view, the Fed in the process of incorporating stronger growth and fiscal stimulus into the policy view, which makes the Summary of Economic Projections due at the March meeting particularly important to keep an eye on.

In the end, we think the FOMC has been doing a respectable job of threading-the-needle between attaining its policy goals (including slowly getting closer to its inflation target) and attempting to avoid potential economic overheating.

This process has been very deliberate and well communicated, and contrary to what some market commentators have suggested, it is not “behind the curve” and doesn’t appear to be in a rush.

The implications for risk-assets (better), front-end yield opportunities (better), and inflation increasing further only moderately (and not in a disruptive manner) are significant. It also suggests to us that the long-end of the curve could well have further downside from here.

That’s particularly the case because duration risk in markets largely extended during the QE-era, so this segment of the market is particularly price-sensitive today, and thus particularly perilous.

Highlights

• FOMC Chair Powell’s Humphrey-Hawkins testimony took centre stage and in his prepared remarks he painted an optimistic picture of labor markets, and growth more broadly, and suggested that he remained unperturbed about below-target inflation, saying it likely reflects “transitory influences
• On monetary policy, Powell made a convincing case that “fiscal policy has become more stimulative and foreign demand for U.S. exports is on a firmer trajectory,” allowing the FOMC to thread-the-needle between returning inflation to target and potential economic overheating
• In our view, the FOMC’s policy rate normalization has been deliberate, and contrary to what some commentators allege, it is not “behind the curve” and doesn’t appear to be in a rush. The implications for risk-assets, front-end yield opportunities, and inflation increasing further (yet not in a disruptive manner) are significant, and it also suggests to us that the long-end of the curve could well have further downside from here