Olivier de Berranger

MACROSCOPE : June 22nd

Jerome Powell’s tightrope act: Time for an end to financial injections?

A little over a year ago, the US Federal Reserve opened the floodgates for a surge of liquidity to respond to what was in many ways an unprecedented crisis. But as we move into summer, the central bank must walk a tightrope to navigate a successful end to an extremely accommodative stance, with key rates close to 0% and monthly asset purchases, or quantitative easing, of USD 120 billion. The situation has certainly changed substantially over a few short months, on the back of vaccination campaigns. Economic growth is skyrocketing, the employment market is returning to normal and inflation is making a surprise return, thus far driven mainly by supply-side constraints. This therefore seems the ideal time for the Fed to start preparing financial markets for an end to its liquidity injections as the scars of the crisis for the US economy fade.

Powell follows tradition of central bankers

Just like his predecessors, Fed Chair Powell has taken tentative first steps along the tightrope. He is following the finest central banking tradition, whereby one of his notable predecessors, Alan Greenspan, was famous for having stated:”If you understood me, it is undoubtedly because I expressed myself poorly.” Mr Powell is therefore also setting on a lurching course. To hint at the possibility of phasing out the financial injections, he talks about contemplating “a discussion about further discussions to come”.

This issue is definitely a minefield after the 2013 “taper tantrum”, when markets were destabilised by the Fed’s abrupt announcement that it was ending quantitative easing. Fed Chair at the time, Ben Bernanke, has bequeathed a few expressions to the central banking repertoire, talking of “easing up on the gas pedal as the car begins to pick up speed, not applying the brakes”. A Fed member at the time, Jeffrey Lacker, also features prominently for his evocation of backpedalling: “the Federal Reserve is not only leaving the punch bowl in place, we’re continuing to spike the punch, though at a decreasing rate over the next year”.

Markets react positively to latest Fed statements

Whilst unseasoned observers may be perplexed by the central banker’s tone, last week’s exercise seems to have been a success, despite a less impressive speech than expected and in spite of the anticipation of an earlier start to rate rises by Fed members. The reaction of markets afterwards is testimony to this. After rising in the hours following the Fed’s announcements, long-term rates ultimately subsided the next day. US equity markets also more or less welcomed the news, including sectors that are most sensitive to interest rate rises: the Nasdaq hit a new high on the following trading day.

Jerome Powell’s first step on the tightrope looks to have been successful. But he will need to keep up the balancing act for some time yet. There could be pitfalls along the way if inflationary pressures prove sustainable, or if the employment market normalises more quickly or evenly than anticipated.