By Nick Timiraos
Flexibility is emerging as the hallmark of Jerome Powell's
response to the first economic curveball he has faced during his
tenure as Federal Reserve chairman.
On two fronts -- interest rates and the Fed's asset portfolio --
Mr. Powell has abruptly changed course in just three months. In
doing so, Mr. Powell is showing he cares more about crafting what
he thinks is the right policy than winning an argument with either
markets or economists.
The twin pivots were "quick by Fed standards," said Steven
Blitz, chief U.S. economist at TS Lombard.
The Fed and the markets fell out of sync after the central bank
raised its short-term benchmark in December and signaled two more
increases this year. Mr. Powell also signaled then that officials
saw little reason to adjust the steady runoff of their $4 trillion
asset portfolio, which had been shrinking by about $40 billion
every month.
Many investors, worried about rising risks to U.S. growth from
abroad and from political uncertainty, had hoped the Fed would
suggest it might not raise rates at all in 2019. Others said the
portfolio runoff was tightening policy too much.
By Wednesday, the Fed had given the market what it wanted in
December. On rates, the Fed signaled it is indefinitely on hold due
to heightened risks to the global economy and because strong U.S.
growth and falling unemployment last year didn't deliver an
expected upturn in inflation.
On the portfolio, most Fed officials still don't believe the
runoff of their mortgage and Treasury holdings played a major role
in the market's swoon late last year.
The drawdown of Treasurys and offsetting bank deposits, or
reserves, from the Fed's balance sheet has been accompanied by an
equivalent increase in Treasury securities held by banks. This
undercuts the idea pushed by some investors that the balance-sheet
runoff was draining liquidity from the financial system.
But rather than trying to prove its argument to markets, the Fed
moved up plans to announce how and when it would stop shrinking its
holdings. The central bank said Wednesday it would slow the pace of
Treasury-bond redemptions in May and end the runoff by October. It
hasn't yet said when it will allow the balance sheet to expand,
which will stop the gradual decline of bank reserves.
"We're in this situation where the chairman of the Federal
Reserve is the most flexible actor on the stage today, and that's
not usually the case at the Fed," said Jim Vogel, a rate strategist
at FTN Financial.
The path hasn't always been a smooth one for Mr. Powell, who
like every new Fed leader faced early communications missteps. The
recent about-face led some analysts to warn that the Fed is
introducing more uncertainty about how it will react to future
changes in the economy or that it erred with December's rate
increase.
Mr. Powell became Fed chairman 13 months ago facing a different
economic environment. Back then, the Fed's models suggested
inflation was likely to rise amid declining unemployment, tax cuts
and a federal spending boost.
By September, more Fed officials were talking about the need to
raise rates eventually to a level high enough to curb growth.
Markets began falling in October and turned more volatile in
November and December. China and Europe showed more indications of
a slowdown, following weakness that buffeted some emerging-market
economies earlier in the year. Meanwhile, trade tensions between
Beijing and Washington showed few signs of easing.
Volatility accelerated after the Fed's December rate increase.
Corporate borrowing costs widened, while government-bond yields
tumbled.
By January, various recession indicators began flashing caution.
One such measure highlighted by Fed researchers last summer, which
compares the difference between the yields on three-month Treasury
bills and the yield implied by futures markets for the same bills
some six quarters later, turned negative. In January, it showed a
50% probability of recession.
Mr. Powell signaled the Fed was pausing from raising rates when
he spoke at an economics conference in Atlanta on Jan. 4. Officials
hardened that commitment after their statement on Jan. 30 dropped
language about future rate rises, and again on Wednesday, when most
of them projected no increases this year.
"Even if it's wrong, the speed with which they're moving is
impressive," said Mr. Vogel.
Mr. Powell's stance reflects a risk-management approach that
tries to balance the risks of policy being too loose, fueling
unwanted inflation or asset bubbles, with the risks that the
central bank could tighten policy too much and prematurely end the
expansion.
Mr. Powell appears eager now to accept the risk that the economy
stabilizes and the Fed is forced to raise rates again. "They're
totally willing to accept that trade-off, because it means they
have avoided a minor recession," said Mr. Blitz.
Mr. Powell has previously noted how the Fed has much less margin
for error when rates are historically low, as now, with its
benchmark rate in a range between 2.25% and 2.5%. If growth
falters, policy makers run out of room to cut rates once they are
lowered to zero, which central bankers call the "zero lower
bound."
"You're not away from the zero lower bound the week you lift
off," Mr. Powell said in November 2016, when the Fed had raised its
benchmark rate just once from near zero. So long as the benchmark
rate is below 3%, "you're thinking, 'I need to be careful here,'"
he said.
Write to Nick Timiraos at nick.timiraos@wsj.com
(END) Dow Jones Newswires
March 22, 2019 05:44 ET (09:44 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.