The Big Picture
The Q&A portion of Fed Chair Powell's testimony on the Coronavirus and CARES Act before the Senate Banking Committee this week was chock full of market-moving insight. That was the case because it produced its fair share of surprises.
The comments that caught everyone's attention -- and which rattled the market -- were his acknowledgment that it is time to retire the word "transitory" when talking about inflation and that he thinks it is time to talk about wrapping up the taper perhaps a few months sooner.
Admittedly, we didn't expect to hear him say that this week, but regular readers know that we think he should have said that months ago.
Inflation on the Fed Chair's Mind
Below are some of the observations from the Fed chair during his testimony:
--The risk of persistent inflation has risen.
--The factors pushing inflation upward will linger well into next year.
--Greater concerns about the virus could reduce people's willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.
--High inflation is a risk to returning to full employment.
--Higher prices have spread more broadly.
--The inflation test we have articulated has clearly been met now.
--It is a good time to retire the word "transitory" for inflation.
--It is appropriate in my view to discuss at the next meeting about wrapping up the taper perhaps a few months sooner.
See any commonalities in the Fed chair's inflation comments? We suspect you do, as it was clear in the fullness of his remarks on inflation that the Fed chair wanted to affect a shift in the market's thinking about the Fed's monetary policy path.
Missing the Mark
When news of the Omicron variant broke the Friday after Thanksgiving, and global equity markets were getting clobbered, there was a quick-footed assumption that it would compel the Fed to take a more cautious-minded approach with its tapering plan, and, by default, with its rate-hike timing.
What Fed Chair Powell did with his remarks, however, was put the market on notice that keeping inflation pressures in check is the new top priority. From our vantage point, satisfying the price stability side of the Fed's dual mandate is now going to supplant achieving maximum employment as the main policy driver.
The Omicron variant is not a risk that has been embedded in the Fed's current forecasts, but even so, Fed Chair Powell made it sound as if the bigger risk related to Omicron is more on the inflation side than on the labor market side of things. Hence, he made it a point to highlight in his prepared remarks that a reduced willingness to work in person could intensify supply-chain disruptions, from which we can infer that there is an expectation that it would contribute to inflation pressures lasting longer.
Effectively, then, the market had to re-think its Black Friday (or Red Friday) assumptions. The Fed, likely, will be adopting a plan to speed up the pace of its tapering plan, such that it is completed now by March or April, as opposed to June.
The Fed will do so to give it more optionality with the timing of its first rate hike off the zero bound, but it will do so because the Fed finally recognizes, with the inflation rate at a 30-year high of 6.2%, the unemployment rate at 4.2%, and the Atlanta Fed's GDPNow model estimating 9.7% growth in Q4 real GDP, that it is ludicrous to still be buying Treasury and agency mortgage-backed securities and holding the target range for the fed funds rate at the zero bound.
We hope, at least, that is what the Fed is recognizing.
From our vantage point, the implication of the Fed chair's remarks before the Senate Banking Committee is that the Fed knows it missed the mark with its transitory inflation view, that it needs to speed things up with its tapering plan, and that the shift is on from a dovish policy stance to a less dovish policy stance.
What It All Means
The candid observations from the Fed chair about inflation have changed the narrative by forcing a re-think of the dovish-minded view the market thought the Omicron variant might trigger at the Fed.
It is also forcing a re-think of lofty equity valuations, which has translated into some sizable losses for many high-multiple growth stocks. It is something we thought would happen with an abrupt shift in policy support.
The ironic thing is that the Fed hasn't even done anything yet to follow through on Fed Chair Powell's remarks. The sensitivity to Fed Chair Powell's pivot, however, underscores just how inflated some stocks had gotten on the expectation that the Fed wasn't anywhere close to raising the fed funds rate.
Now, with the Fed chair suggesting he thinks the tapering pace should happen faster, there is a residual expectation that rate hikes will follow relatively soon after the tapering is complete.
When the first rate hike does happen, the policy rate will still be extraordinarily low. Nonetheless, the abrupt pivot by Fed Chair Powell is tantamount to issuing the first signal that the "party like it's 1999 vibe" is coming to an end.
