Four more years of Powell

Four more years

Yesterday it was announced that Jerome Powell will be appointed for a second four-year term as governor of the Federal Reserve. Not an insignificant event since central bankers have played a very prominent role in the economy and the stock markets since the credit crisis. And the Federal Reserve is still considered the most important central bank. In fact, the Fed is not only the central bank of the United States, but of the world. Stock markets initially rallied only to give up their gains towards the end of the day. The Nasdaq even closed with a loss of 1.3 percent. Interest rates on both 2-year and 10-year government bonds rose.

Biden’s choice

With President Biden’s nomination of Powell, two things became clear. First, the moderate Democrats within the party appear to have the upper hand over the progressives, who after all had a strong preference for opponent Lael Brainard. This more dovish opponent of Powell will become vice president. Second, with this choice Biden made it clear that rising inflation is starting to become a problem for him. Powell is seen as the one who can best combat that problem.

Interest rates lag behind

Because fighting the danger of inflation will become the Fed governor’s main task in the coming years. Recently, the consumer price index in the United States was found to be up by a whopping 6.2 percent. A level the markets had not seen for 30 years. Rising inflation normally brings higher interest rates. The big mystery at the moment, however, is the fact that interest rates just won’t go up. For example, despite the sharp rise in inflation, the 10-year interest rate in the United States is still only 1.63 percent. That’s a lot lower than in the spring, when inflation didn’t rise as fast.

Why?

The big question among investors is why the interest rate is lagging behind. Because adjusted for 10-year inflation expectations, the real interest rate in the United States is still more than 1 percent negative. And that while the labor market is picking up hard, corporate profits are far exceeding expectations and the housing market is booming. The Federal Reserve of Atlanta even expects economic growth in the fourth quarter of around 8 percent on an annual basis! Surely such figures do not include a paltry 1.63 percent interest rate?

Temporary?

The reason often given is that the market still believes the central bankers’ story that this inflation is only temporary. The inflated prices for commodities, transportation costs and wage increases are said to be merely the result of a mismatch between supply and demand due to the rapid recovery from the pandemic. Another, not uninteresting, reason is that the U.S. economy is so heavily burdened with debt that any interest rate increase will immediately snap any bit of economic growth in the bud. The U.S. economy — like the world economy — can no longer handle a serious interest rate hike at all.

Preview

Should the Federal Reserve step on the brakes, a strong correction in the stock markets is likely to follow. We saw a foretaste of this three years ago. When Powell decided on multiple interest rate hikes in the fourth quarter of 2018, the S&P 500 plummeted by 20 percent. Powell had to retrace his steps immediately.

Debt Trap

The United States — and, in fact, the entire global economy — is in a debt trap. The debt burden is so large that any increase in interest rates will result in major damage. How to get out of this without a solid recession? The Federal Reserve seems to have been making a tentative attempt for several months. Since the beginning of September, the Fed continued to buy up $373 billion worth of government and mortgage bonds, further easing the markets. At the same time, it sold — through repo transactions — 438 billion worth of bonds in the same period. In fact, the Fed is already tightening. Despite this tightening, the S&P 500 set 12 new All-Time Highs during this period. This is a true balancing act. Powell may continue to dance on a thin tightrope for another four years. The financial markets are watching breathlessly.

Photo: REUTERS/Brendan McDermid

Chelton Wealth — Operated by Chelton GmbH is an independent asset manager. We serve (ultra) high-net-worth individuals, institutions, funds of hedge funds, private banks, family offices, NGO’s and entrepreneurs with independent and personal asset management. If you would also like to be kept up to date with the latest news, please sign up here for our weekly newsletter. Would you like to know more about the possibilities? Then request a callback. We will contact you without obligation.

Photo: REUTERS/Brendan McDermid

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Robert J. Teuwissen

Robert J. Teuwissen

Financial Services Entrepreneur

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