Markets Race to Process Latest ‘Powell Pivot’

(Bloomberg Opinion) -- Markets just witnessed another “Powell pivot.”

Federal Reserve Chair Jerome Powell has long held a sanguine view about this year's sharp increase in U.S. inflation. Time and again, he wrote off the spike as “transitory” — something that would fix itself over time. In his much-anticipated Jackson Hole speech in August, he presented a one-sided case for why price pressures were no reason for alarm.

Yet just about a week removed from being picked by President Joe Biden to lead the U.S. central bank for four more years, he left little doubt about where he now stands on the inflation debate. He's ready to shift the Fed into inflation-fighting mode.

Sprinkled throughout Powell's testimony to the Senate Banking Committee were subtle hints that combating inflation was top of mind. In his prepared remarks, he noted that “factors pushing inflation upward will linger well into next year” and that the central bank realizes the burden that places on lower-income households. But he also went out of his way to emphasize that price pressures were becoming broader than just a few items. Even on a question about labor force participation, he brought up price stability. He also added that it was “a good time to retire” the word transitory, a tacit admission that the Fed has lost the narrative.

But for markets, it was Powell's unambiguous response to a question about the Fed's plans for scaling back asset purchases that was the tell that something has clearly changed within the central bank:  

“At this point the economy is very strong and inflationary pressures are high and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases perhaps a few months sooner. And I expect that we will discuss that at our upcoming meeting in a couple of weeks.”

Remember that it was only weeks ago that Fed officials agreed it was appropriate to reduce bond buying by $15 billion a month, meaning asset purchases would end in mid-2022. I wrote at the time that Powell and his colleagues had given themselves eight months to keep bond traders from pricing in faster-than-expected interest-rate increases.

The consensus within the central bank now appears to be that waiting until next June is far too long. St. Louis Fed President James Bullard was first to suggest winding down bond purchases by March and was soon followed by Governor Christopher Waller and Vice Chair Richard Clarida. Atlanta Fed President Raphael Bostic said he was “very open to accelerating the pace of our slowdown in purchases” during an interview last Friday, remaining steadfast in the face of turbulent financial markets. Even San Francisco Fed President Mary Daly, who leans dovish, said that she would support an accelerated tapering process if data remained strong.

But Powell's words carry far more weight than even a broad swath of regional bank presidents and other board members. This feels like the hawkish equivalent of his January 2019 “pivot,” when he abruptly shifted from signaling further tightening of monetary policy to preaching patience after a widespread retreat in risk assets to end 2018. He has morphed from the captain of “team transitory” to retiring the word altogether.

Bond traders quickly took notice. The five-year Treasury yield jumped about 14 basis points in the span of a half-hour starting at 10:23 a.m. in New York. The yield curve from two to 10 years is the flattest since January, at about 90 basis points, while the 30-year yield fell to 1.78%, the lowest since January. All of that indicates expectations of rate increases in the coming years but no runaway economic growth or inflation. Indeed, break-even rates across the curve are in decline after soaring in the wake of data showing the consumer price index soared 6.2% in October from a year earlier.

These moves are perfectly consistent with a Powell pivot toward faster tapering, as was the retreat in stocks. They also reflect the new message from the Fed: We will not let prices get away from us. It shouldn't be lost on anyone that Powell was testifying Tuesday in front of a bipartisan group of U.S. senators. He needs them to confirm him to a second term, while their own political fortunes in part depend upon developments in the U.S. economy — and inflation specifically.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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