2023-03-15 11:43:10 ET
Summary
- Jerome Powell and the Federal Reserve presently face major problems in the banking system and a 6.0 percent, year-over-year rate of inflation.
- Facing this dilemma, the investment community does not seem to have a great deal of confidence in Mr. Powell and the Federal Reserve System.
- This lack of confidence has been building since Mr. Powell became the Chairman of the Board of Directors of the Federal Reserve System.
- What will Mr. Powell and the Fed choose, to continue their path to bring down the rate of inflation or to concentrate on making sure the banking system avoids a major collapse?
- To many investors, Mr. Powell's legacy is to always err on the side of monetary ease, an approach that many in the investment community brought us to this point.
Jerome Powell, Chairman of the Board of Governors of the Federal Reserve System, faces a real dilemma.
Mr. Powell and the Federal Reserve have been fighting the inflation going on in the United States for a year now, have been engaged in quantitative tightening of the Fed's balance sheet, and have been constantly raising the Fed's policy rate of interest.
Yesterday, the word came in that the inflation rate the Federal Reserve is concentrating on showed a 6.0 percent, year-over-year, rate of increase. This was down modestly from the January number, but substantially above the 2.0 percent target rate that the Federal Reserve is shooting for.
This was not the best of news, especially since Mr. Powell and the Federal Reserve are now facing another battle.
The new battle is the stability of the United States banking system.
With three banking failures in the past week or so, the quick and expansive response of the banking regulators, and the continued concern about further problems in the banking system, Mr. Powell and the Federal Reserve are confronted with the need to be prudent and careful about what it does with monetary policy in the near future.
The question is, can Mr. Powell and the Federal Reserve continue to fight inflation with the same intensity it had been fighting it, and care for the liquidity and solvency of the banking system in the face of the current bank failures?
Mr. Powell and the Federal Reserve seem to be facing a real challenge.
Past History
The problem that investors face is discerning how Mr. Powell is going to react to this dilemma.
Unfortunately, in the minds of many investors, Mr. Powell has not reacted to the events occurring since he has been the Chairman in the best fashion.
Unfortunately, in the minds of many investors, Mr. Powell, in making very consequential decisions, has always opted to choose the path that errs on the side of monetary ease.
Mr. Powell, to many investors, seems very intent upon not letting his name go down in the history books as the head of a Federal Reserve that oversaw a major financial crisis.
Mr. Powell faced the events surrounding the spread of the Covid-19 pandemic and the economic recession that followed.
Mr. Powell's response was looked at by many, as an effort to err on the side of monetary ease so that the U.S. financial system and the economy would not collapse.
Mr. Powell and the Federal Reserve succeeded in their efforts to put a floor under the U.S. financial system and the economy and recovery followed.
The criticism that followed this effort was that Mr. Powell, and the Fed, in their effort to avoid a downside catastrophe, set the stage for an upside problem in the future.
In "protecting the downside," Mr. Powell and the Federal Reserve created an asset bubble . Something to be dealt with later.
Then the prospect of runaway inflation came to the fore. Mr. Powell and the Fed, for as long as they could, pushed off the need for the monetary authority to respond to this problem by claiming that the inflation was just "temporary."
The inflation was a temporary response of the economy to all the supply chain problems and energy problems, among other things, that would soon go away because they were not a result of lasting distortions.
They were wrong and eventually claimed that inflation was a problem that needed Federal Reserve attention.
And so, Mr. Powell and the Federal Reserve, at the March 16, 2022 meeting of the Federal Open Market Committee meeting, agreed to begin raising the Fed's policy rate of interest and to begin a program of quantitative tightening,
Even though Mr. Powell and the Federal Reserve continued to raise the policy rate of interest and to execute a program of quantitative easing, the investment community just did not seem to believe that Mr. Powell and the Fed would stick to this policy stance.
A major example of this "lack of belief" in the staying power of Mr. Powell and the Federal Reserve, was the performance of the stock market.
Note that this chart begins on March 16, 2022, the day of the meeting of the Fed's FOMC, the day that the fight against inflation officially began.
Note, that stock prices initially declined as investors took the Fed's actions seriously, as investors took the "tightening" of the Fed as an indication that the economy would go into a recession and that corporate earnings would suffer, and so, stock prices should fall.
But, over and over again through the summer and into the fall, investors kept believing that the Mr. Powell and the Federal Reserve would "pivot" and reverse their policy of monetary tightening.
The reason?
Investors believed that Mr. Powell did not want to see a stock market "crash" and so would back off from the policy of monetary tightening...sooner rather than later.
This attitude continued through the summer of 2022, into the fall of 2022 and then into the new year, 2023.
The feeling, constantly during this period, was that Mr. Powell would not let the stock market fall. Investors believed that Mr. Powell was always on the verge of "backing off" from the tight money.
The Legacy
This is the legacy that Mr. Powell and "the Powell" Federal Reserve has to live with.
And, I believe, it is a prominent feeling within the investment community as we start to resolve this current dilemma.
In one sense, it is positive for the current banking crisis.
If Mr. Powell always errs on the side of monetary ease, then banks will be protected, runs will be avoided, and a catastrophe will be avoided.
Of course, the fight against inflation will be put on the back shelf to be re-introduced once the banking situation is resolved.
But, the Mr. Powell and the Fed will have "backed off"...Mr. Powell and the Fed will have pivoted.
The investment community will claim that it is right!
But, the inflation battle is still going to have to be fought.
The dilemma is rather stark!
But, we have Mr. Powell and the Federal Reserve to deal with it.
For further details see:
Mr. Powell's Dilemma