Questions for Chairman Powell
What does he make of the surge in asset prices and bond yields?
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Federal Reserve Chairman Jerome Powell makes his semiannual appearance on Capitol Hill this week. Investors have a few questions, and so should Members of Congress.
The first concerns what Mr. Powell thinks is happening in markets, especially bond yields that are rising again. The yield on the 10-year Treasury note—the most important price in the global economy—surged to 1.37% Monday from 0.917% at the start of the year. The German 10-year bund, the eurozone’s benchmark bond, on Monday hit an eight-month high of minus-0.28%, after rising 12 basis points last week. Japan’s 10-year government bond reached a two-year high of 0.12%.
No doubt this is in part a healthy response to good pandemic news. Falling case counts in the U.S., U.K. and other vaccine leaders are bringing the light at the end of the lockdowns into sight. Bond investors expect growth to revive, and rising yields signal faster growth. If this is correct, expect economic optimism to push yields still higher despite the Fed’s near-zero short-term rate target and aggressive asset purchases.
But Mr. Powell has gone to extraordinary lengths to keep yields low, so how does he view these recent bond movements? Is this healthy, and is he content for investors to make their best guesses about the recovery? Or does he intend to fight investors, perhaps with some version of Japanese-style yield-curve control that would set rates by fiat at longer maturities? If so, why?
A less benign reading of bond-price trends is that investors expect that the combination of economic recovery, loose monetary policy and a fiscal blowout from the Biden Administration will stoke inflation. An early warning might be last week’s report of a 1.3% January increase in producer prices, a post-2009 high.
Inflation already is here if you look at asset and commodity markets instead of consumer prices. Bitcoin is up about 80% this year despite an Elon Musk-induced plunge Monday; copper has nearly doubled in price per ton since March; emerging-market bonds have been issued in higher-than-normal quantities this year, at abnormally low interest rates; the S&P 500 and Nasdaq set new records this month; the U.N.’s index for global food-commodity prices reached its highest level since 2014 in January; the Case-Shiller housing index rose 9.5% in November, the fastest pace since 2014; and Brent crude oil is back to about $65 a barrel.
Some of that is related to rosier economic growth prospects after a terrible year. But how much? Some of the price rises appear to be attributable to less benign supply pinches as the economy continues to adapt to the post-Covid era. Nor can one ignore the phenomenal 26% increase in the money supply as measured by M2, which John Greenwood and Steve H. Hanke flagged in these pages Monday.
Which brings us back to Mr. Powell, who with his predecessor, Treasury Secretary Janet Yellen, seems convinced that since inflation didn’t ignite after 2009 it never will again. He also sounds sanguine about the risks of soaring asset prices, for which he’s said monetary policy isn’t a suitable remedy anyway.
What, precisely, makes him so sure inflation isn’t a danger? Is he recalibrating his inflation expectations in light of the unprecedented runup in household savings over the past year, a fiscal blowout of world-historical proportions, and much faster growth in monetary aggregates than occurred after 2009? If not, why not?
Another question is what Mr. Powell plans to do about any of this. Following its strategic review last year, the Fed adopted a new “average inflation target” scheme. Whereas the central bank used to view its 2% consumer-price inflation target as a ceiling, it now views that as an average. Mr. Powell promises to “look through” periods of higher consumer-price inflation to compensate for previous periods of below-target inflation.
How much looking-through does Mr. Powell plan to do if inflation does re-emerge? He’s reassured voters, politicians and markets that if perchance the combination of monetary and fiscal stimulus stokes inflation, the Fed will be able to control it. How will he know when we’ve reached that point?
Congress may ignore all of this since most Members simply want the fiscal and monetary stimulus party to continue. But rest assured the markets are asking these questions. As economic historian Charles Kindleberger documented in his history of financial crises, every mania and panic has in common the excessive supply of credit.
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