Is Powell a Volcker in Sheep's Clothing or Going Out Like a Lamb?

The Fed Over the Last Year

March 3^rd, 2022: Senator Shelby asked Fed chair Jay Powell: “Volcker put the economy in a recession to get inflation under control. Are you prepared to do what it takes to get inflation under control?" Powell replied: "I hope history will record that the answer to your question is yes."

This was the exchange that made the biggest impression on me a year ago. Shelby gave Powell the rope to say he’d burn the economy in order to get inflation under control without actually saying it – the direct question itself only asked whether Powell would, more Draghi-like, ‘do whatever it takes’. Is it coming true? The Fed soon thereafter embarked on an unprecedented pace of hikes, raising interest rates by a cumulative 450bps in the following 12 months. But there is no recession – at least officially – so far. Will there be? Powell and his colleagues may be starting to panic a bit that inflation is not going away and the economy – the labour market in particular – is holding up too strong. Some think this the soft-landing playbook – but without inflation coming down there is no ‘landing’ per se, only an economy running below potential and prices that keep on rising.

More Hawkish? Maybe Not.

We’ve heard a lot from Jay Powell – higher for longer, though yesterday he strenuously made the point that the Fed is data-dependent: “We’re not on a pre-set course”. We’ve had plenty of solid eco data – stronger-than-expected private payrolls numbers from ADP yesterday being the latest to cement the view the US economy is holding up ok in the face of rate hikes – so far. And we keep seeing inflation coming in hotter than we’d like. And yet stocks are holding up ok – the FTSE is marking time around 7,900, close enough to its recent all-time high to suggest there is no grave concern about the global economy; the DAX holds just a little way off its best since Jan 2022; in the US the S&P 500 is still over 10% above its lows. The UK and US is basically flat this week, while German is up solidly. Investors are starting to buy into ‘higher for longer’ – but the data could still see a shift that takes the pressure off the Fed. The question is when – the rate hikes will catch up soon enough and the reacceleration in hiking will seal the deal. Before that, stocks should come under some serious pressure once more – once the idea of a pivot is not just off the table for tomorrow and the next day, but off the table the next year or three.

Fed Up

The problem for the Fed is this: they looked at a batch of data and saw disinflation and ignored what was going on around them. Sticking with 25bps this month would risk further loosening of financial conditions, which will only make the job to tame inflation harder. Unless there is a stinker of a jobs report tomorrow, the Fed will either need to go with 50bps or do 25bps and stress a much higher terminal rate. And this comes back to the central dilemma – once a structural inflationary dynamic is let loose, the only way to rein it back in is to crash the economy, Volcker style. 

Europe Continues to Falter

Stocks are lower this morning in Europe, with the FTSE 100 down around 0.5%, led by declines for basic resources stocks amid some weaker China inflation data and downwards revisions to Japanese GDP overnight. There were milder declines for Paris and Frankfurt at the open. The strong bid we saw for the US dollar in the wake of Tuesday’s hawkish statement has eased and the DXY is flat a little way above 105. The US 10yr Treasury yield holds 4%, with the 2yr at 5%. Wall Street was mixed yesterday with the Dow down a tad and the S&P 500 up a touch and the Nasdaq more confidently up 0.4%.

Data Watch

Japan’s Q4 GDP revised down from annualised +0.6% to +0.1%.China inflation was lower than expected with headline CPI at 1.0% vs 1.9% expected while PPI remains in negative territory at -1.4% vs -0.8% prior.

In the US, ADP’s private payrolls rose by 242,000 in Feb versus the estimate for 205,000 and up from 119,000 in January. Wage growth eased somewhat which should be good for the Fed except it’s still running at +7.2% for those remaining in their jobs and at +14.3% for those switching. The Fed’s Beige Book reported that "Overall economic activity increased slightly in early 2023" but "amid heightened uncertainty, contacts did not expect economic conditions to improve much in the months ahead". Challenger jobs cuts and weekly unemployment claims are today’s amuse bouche to tomorrow’s nonfarm payrolls.

Sterling has recovered a little from its multi-month lows. GBPUSD touching 1.1860 having hit 1.180, its weakest since November. Chiefly a bit of giveback from the dollar’s post-Powell rally.