Editor’s Note: Thanks to Carrier Management for featuring my recent post on The Reinsurer’s Veto. You can find the article here.
No, I’m not calling the Fed Chair dumb. I’m calling him a dummy. There’s a difference. A dummy is controlled by a ventriloquist who gives it voice. The dummy is neither smart, nor dumb. It is only a vessel to express the ventriloquist’s thoughts.
Similarly, Jerome Powell is controlled by the bond markets which tell him what to say. He does not have an original thought in his head, or at least not one he is willing to express.
He is no more than a dumb terminal controlled by a Bloomberg terminal. He can only express the thoughts put in his mouth by Mr. Market.
Working As Intended
I don’t say this to be pejorative. I believe he is working as intended. His job is to follow the bond market’s lead. That may not be what the job of Fed Chair is supposed to be, but, in our current times, that is what he was appointed to do.
Why do I say that? Look at the evidence. Powell never surprises the market. Quite the opposite. He does exactly what the market wants him to do.
If the market says the Fed is behind the curve, rest assured at the next meeting Powell will raise more than was originally expected.
If ten year yields come down too much because the market fears recession, Powell inevitably promises future cuts (or a slowdown in hike).
Just look at this year. The market didn’t like the Fed was going 25bp at a time, so Powell changed his mind in May and raised 50bp. But everyone said the Fed was still behind and needed to go faster, so what did Powell do? He promised 75bp in June.
The market wanted Powell to go even faster and higher due to fears inflation was out of control so Powell promised another 75bp in July. After all, inflation was hitting 40 year highs!
But what happened along the way? The market freaked about recession and the yield curve began to invert. Yet inflation continued to hit new highs.
What is a dummy to do? Fight inflation and the market throws a fit. Ease off because of recession fears and watch yields spike.
Doing the Market’s Bidding
There was only one decision he could make. Go through with the 75bp as promised but then appease the bond market by backing off future hikes.
After all, the market was discounting that the Fed would raise rates too far and have to turn around and cut next year. That really didn’t make any sense. Even the ventriloquist was confused!
Either inflation would remain a problem and the market would realize no rate cuts were in the offing or inflation would slow and the Fed would eventually back off hikes. To bake in rate cuts though, suggested a bet on the Fed making a mistake.
That message scrambled the Fed’s circuits, so it was time for a script change. Rather than say they would remain data dependent and react to events, once again, Powell let the markets tell him what he had to do rather than make his own decisions based on the facts as he sees them.
While the smart money is suggesting inflation has peaked, actual reported inflation continues to hit new highs. While the market may well be correct, I thought the Fed promised to be data dependent?
Doesn’t the data say inflation is still the bigger threat? So how can they back off inflation fighting at this time? Oh, right, because Mr. Market told them to do so and the dummy spoke the words.
Telephone Tag
Now, I know what some of you will say. If Powell is no more than a ventriloquist, how come he sometimes (ok, often) gets confused about what the market wants and gives confusing messages?
Look, not all ventriloquists are good at their craft. Sometimes, the dummy doesn’t get the message straight. Think of it like a game of telephone tag. By the time Powell gets the message, it’s often garbled and confusing.
But every time he messes up the translation, what happens next? The market throws a fit and in the coming weeks, the Fed inevitably tells the market it will get what it wants at the next meeting.
I guess you could say Powell is smart for a dummy. He corrects his translation mistakes quickly.
Looking Ahead
So what happens next? Well, that’s pretty obvious. The Fed will again do what the market says.
If the market feels the recession scare was overdone, it will go back to worrying about inflation and demand Powell raise rates further. If the CPI starts to roll over, the market will demand no more rate hikes.
That’s right, the Fed isn’t data dependent. It’s market dependent.
It will be unfortunate unintentional comedy if, by September, the market has gone back to fears over inflation and forced the Fed to do another 75bp. That would certainly whipsaw everyone, but is it such an unthinkable suggestion?
Fed Funds is at 2.5%. The ten year yield is barely higher. Do we really think inflation in a year will be at 2%? Because if it’s not, rates need to be higher since real rates need to be positive. It’s really that simple.
And sometime later this year, Powell will figure that out. Because the market will have told him so.