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Fed policy is crucial to markets and the recovery

Concerns about a sharp rise in US inflation have eased, but Federal Reserve policy remains key to any recovery. Markets may once again test Chairman Jerome Powell’s resolve.

Concerns about a sharp rise in US inflation have eased, but Federal Reserve policy remains key to any recovery. Markets may once again test Chairman Jerome Powell’s resolve.

Charles Stanley

in Features


The US is about to experience a rapid and impressive recovery in output and profits based on the extraordinary amount of stimulus supplied by both the monetary and fiscal authorities. The markets welcome this, but ask how long will the monetary stimulus last? The Fed assures us that it has no plans to raise interest rates anytime soon.

In a recent interview, the one question that Fed Chairman Jerome Powell found difficult was the question about his possible reappointment in February next year when his first four-year term as chairman of the Fed expires. The questioner asserted he had not had a call from the new President to discuss the outlook and must be wondering if he would keep his job. He looked haunted or unhappy, as you would when asked a question about other people's views or conduct which you cannot answer in a helpful way. He looked like a man who would like a second term but is not sure he will get one.

This matters for the conduct of US and wider world financial and monetary policy. Listening to Mr Powell he speaks fluent Democrat. He has done practically everything a Democrat would want of a Fed chair in response to the pandemic, apart from some issues over bank regulation under the previous President.

Mr Powell is not now widely seen as a Trump supporter in the role, and he did have early months of dispute with the former President who wanted him to loosen monetary policy when the Fed disagreed. He subsequently did everything Mr Trump – and the Democrats – wanted to ease conditions to offset some of the pandemic measures. He delighted the Democrats further by his public demands for more fiscal stimulus than many Republicans wanted.

Mr Powell wants to keep his job

Meanwhile, a few left-wing Democrats would rather have their own person replace him and be tougher on the banks. President Joe Biden might think reappointing the incumbent, who is seen to have done a good job, provides a bit of evidence of his wish to reach out beyond the Democrat base and provides some reassuring stability.

The important conclusion of this speculation is that there is enough reason for Mr Powell to hope he is renewed, and plenty of reason why he should carry on stressing his Democrat-friendly policy work to raise his chances. At 68 he is still a youngster to the President. He says plenty about the Fed's role in boosting the labour market as well as controlling inflation. He talks about the need to have a full recovery which stretches into the one fifth on the lowest incomes who have been most hit by the pandemic. He wants to see more people from poorer backgrounds and from disadvantaged communities see more of the benefits of recovery.

So, when Mr Powell tells us he will let the economy run with higher inflation for the next year, and will not throttle back on bond buying or raise interest rates all the time there is substantial unemployment and large areas of low income underemployment, we should believe that is indeed his intention. He thinks it right for the economy and it is certainly necessary to please his employer.

The Fed's view that the US can get away with a double massive stimulus from monetary and fiscal action assumes a rise in inflation based on commodity price rises and supply shortages will be resolved a year or so later by supply increases in response to the surge in demand. Government policy and low interest rates will be helping to increase investment in capacity. The worry is the markets might not believe the inflation rise in a one off and under control, which could force a tightening of policy on a reluctant Fed, just as the markets forced Powell to loosen prior to the pandemic when they thought the Fed was wrong to be shrinking its balance sheet.

Mr Powell's current intention is clearly stated. He does not want to be worried by larger inflation figures which he thinks will prove temporary. He wants to get the average inflation rate closer to 2% which allows him to run above 2% for a bit. He does, however, accept he will need to worry and change tack if inflation expectations also rise when prices go up. He assumes wages will not rise too much and create a price-wage spiral as they used to in the last century.

We will watch these carefully. There remains the possibility that the bond markets seeing inflation, output and profits rising will test the Fed’s resolve again by pushing up longer-term interest rates.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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