Jerome Powell Performs Open-Mouth Operations; Markets Tank

Federal Reserve Chairman Jerome Powell performed some “open mouth operations” on Capitol Hill Tuesday.

Powell talked and the markets freaked out.

During an appearance before a congressional committee, the Fed chair said that with stronger economic data, interest rates would likely peak higher than previously expected. He also admitted that January’s employment, consumer spending, and inflation data indicated that some of the softening trends we saw late last year were reversing. In other words, Powell was forced to concede that the disinflation narrative is unraveling.

The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.”

Powell didn’t say how high rates might ultimately go, but market pricing moved up sharply to a range of 5.5%-5.75%, according to CME Group data. That was up from an estimate of a 5.1% terminal rate in December.

Powell also put a 50-basis point hike at the next meeting on the table.

If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”

A hawkish Powell also emphasized that the Fed “will stay the course until the job is done.”

Powell Talks; The Markets Freak

Reuters called it a “breathtaking Powell jolt.”

The Dow Jones dropped by over 574 points (-1.72%). The S&P500 fell by 1.53%. The NASDAQ plunged 145 points. Meanwhile, the dollar rallied on the promise of tighter monetary policy, with the dollar index jumping by about 1%. That pressured gold, which dropped by about $38 at the low.

This was a repeat of the performance we saw over and over again last year every time somebody at the Fed talked tough about fighting inflation and indicated monetary tightening would continue, or when we got any kind of strong economic data.

The thing most people seem to be missing is that Powell didn’t really say anything he hasn’t been saying all along. Powell talked tough after both the December and February FOMC meetings. After the February meeting, Powell repeatedly said “the job is not done,” and emphasized that “It would be very premature to declare victory, or to think that we’ve really got this.” He indicated that the central bank could raise rates a couple more times.

We’ve raised rates four and a half percentage points, and we’re talking about a couple of more rate hikes to get to that level we think is appropriately restrictive. Why do we think that’s probably necessary? We think because inflation is still running very hot.”

The markets didn’t believe their ears last month. Apparently, they do now.

The Reality

We have rhetoric and we have reality.

Powell is giving a narrative, but here’s the reality – Powell is going to keep talking tough until the economy goes into the gutter. And it will sooner or later. This bubble economy is built on easy money and debt. The Fed has taken that away. So, the house of cards has to come crashing down eventually. When that happens, Powell’s tune will change.

As I discussed in my podcast last Friday, there are three fundamental reasons the Fed will not win this inflation fight.

1. The sheer amount of inflation the government and the Fed have created. The central bank has pumped trillions of dollars into the economy in little over a decade. It needs to dry up that liquidity. It can’t. And it’s not even trying. With the current balance sheet reduction plan, it would take over seven years just to shrink the balance sheet to prepandemic levels. And it’s not even meeting the goals set in this tepid plan.
2. Even at 5.5%, interest rates wouldn’t be high enough to slay inflation – if the Fed can even get them that high before the inevitable crash. Even with the aggressive hiking over the last year, we still have negative real interest rates. And given that the CPI dramatically understates the reality of inflation, real rates are deeply negative. You don’t beat inflation with negative real rates.
3. The federal government won’t stop spending money. The US government is running an extremely expansionary fiscal policy. Furthermore, the Fed will eventually need to step in and monetize at least some of this debt. Monetary policy alone won’t bring inflation back to 2%. We need spending cuts. That’s not happening.

Powell was asked about government spending during his congressional hearing, but he wasn’t willing to directly confront it. After all, the Fed has to maintain its “independence. But Powell claimed the Fed has the tools to bring CPI down to 2%. As Peter Schiff said in a tweet, “Without significant cuts to government spending, and a willingness to allow a financial crisis to run its natural course, the Fed has no tools its willing to use that will do the job.”

#Powell was wrong when he told #Congress that he has the tools to bring #inflation down to 2%. Without significant cuts to government spending, and a willingness to allow a financial crisis to run its natural course, the #Fed has no tools its willing to use that will do the job.

— Peter Schiff (@PeterSchiff) March 7, 2023

A paper published last year by the Kansas City Fed admitted that the central bank couldn’t slay inflation alone. In a nutshell, the paper asserted that US government fiscal policy contributes to inflationary pressure and makes it impossible for the Fed to do its job.

Trend inflation is fully controlled by the monetary authority only when public debt can be successfully stabilized by credible future fiscal plans. When the fiscal authority is not perceived as fully responsible for covering the existing fiscal imbalances, the private sector expects that inflation will rise to ensure sustainability of national debt. As a result, a large fiscal imbalance combined with a weakening fiscal credibility may lead trend inflation to drift away from the long-run target chosen by the monetary authority.”

But the Federal Reserve will keep up the illusion of an inflation fight as long as it can. Until the economy cracks under the pressure of tighter monetary policy, you can expect Powell and Company to keep talking tough.

But at some point, the economy will crack.

The US economy is addicted to easy money. It is addicted to artificially low interest rates and quantitative easing. You can’t take an addict’s drug away without sending him into withdrawal. The economy can only limp along so long with tighter monetary policy.

Interest rates haven’t been this high since 2007. At that point, the Fed was cutting rates due to the housing bust. The economy couldn’t handle interest rates that high then. What makes anybody think it can handle them that high now?

When the inevitable happens, the Fed will almost certainly abandon the inflation fight to rescue the economy.

Until then, you can expect more open-mouth operations by Powell and his minions.

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