Fed Watch: "The Quiet Guy in the Background"
Danielle DiMartino Booth provides a masterclass on the "METHODICAL" Fed Chair Jerome Powell.
Discussion
Much like Julian Brigden, DDB has been mission critical in supplementing and confirming my own analysis of the Powell Fed. For instance, last May she confirmed that once Powell was officially confirmed that he was going to move HARD. It’s no accident that within two months of his May 12 confirmation that the 3y/10y UST curve moved above 100% and has never returned. When DDB talks, we listen.
The Powell Fed is running very tight monetary policy, but it’s obfuscated by Powell’s “methodical” nature - the key word of DDB’s interview.
Interview Notes & Quotes
Minute 2:35: Methodical.
Back in 2015 Richard Fisher told DDB to pay attention to Jay Powell. “Keep your eye on one person” (Fisher)
“Jay Powell really wants to shrink the balance sheet” (Fisher)
“He doesn’t have to be there…he’s there for a different reason” (Fisher)
“Powell is the bad guy. And he’s allowing himself to be the bad guy. So, why? is the question.” (DDB)
“It sounds so cheesy, but I think [what’s driving him] is patriotism."
“I think he’s a patriot, or he would not be subjecting himself to this kind of torture.”
Minute 7:55: Price discovery.
“They [investors] are dealing with it [price discovery] now. Leveraged loan recoveries…today are 33 cents on the dollar. That’s your starting block.”
“As long as he [Powell] methodically continues one week at a time, one month at a time, to hold steady, it doesn’t matter if rates are rising or not, if you have to refinance into this sh$t show, what a mess. Because your doubling or tripling your financing costs regardless of who you are.”
Minute 9:35: The balance sheet.
Pause in hikes doesn’t mean a concurrent pause in QT
“He’s very methodical when it comes to the balance sheet”
“It’s working. It’s just working really slowly. He’s good with that. He’s wayyyy happy with retail investors and 0DTE keeping the stock market going, he’s happy with all of this, because it gives him cover to keep going.”
Minute 11:35: Three broken tools. Gone.
“You can have the capital markets be crippled, which they are right now, but you cannot have them freeze, completely. You’ve got to have somebody out there floating a deal.”
“He is extremely methodical about this. Go back to 2018. When he took rates back down to zero, what did he have to play with? 250 basis points. Now let’s say he has decided that 2% is the new zero. Let’s just say that ZIRP is a tool that’s being tossed out of the toolbox. He’s got 300+ basis points to work with to come down to the new 2% floor.”
“He knows he can get rid of QE. He just can. Just throw that out of the toolbox right there with it [ZIRP].”
“And by the way, as a little bonus round, when he does eventually lower interest rates, he can just let those MBS roll off the balance sheet as they prepay, and just have that occur in the background as well, and get the Fed out of the credit easing business.”
“He knows he can get rid of three tools at once [ZIRP, QE, credit easing] that are broken…if he’s calm. If he’s the quiet guy in the background who just steadily keeps going.”
Minute 17: Banking system.
Systemic risk flashed with SVB, so a backstop was needed. But…
BTFP was not “free” - “Now we know why Congress grilled him about raising capital requirements”
“For a $2 trillion facility to have 5% uptake? Banks have figured out that there’s nothing free about it.”
In CRE, garbage and A+ properties are trading. The stuff in the middle is not trading
Bankers are hoping rates come back down to 0% so they don’t need to trade stuff in the middle. But maturity wall is this year
“If he [Powell] can just hold on for 6 more months, then the middle is going to trade, because it has to trade. And that will take out quite a few players.”
Concluding Thoughts
There’s actually a pretty bullish (for equities) element to DDB’s interview: If Powell is happy with equities up so that he can continue squeezing the economy via rates and QT, then focusing on equity market liquidity and positioning becomes that much more important for timing the ultimate decline. The problem with this point of view is what Brigden outlined about the importance of the equity market vis-a-vis labor market loosening. If Powell wants the equity market up so he can raise rates and shrink the balance sheet, then the hit to Main Street will be that much worse, and thus the ultimate economic damage overall ends up being that much worse given the importance of Main Street to the overall health of the economy. In the end, equities are staring down a standard recessionary bear market decline to somewhere circa SPX 2500, it’s just going to take awhile to get there, but when it does it will be violent.
DDB’s comments about bankers hanging on for lower rates are very interesting, because in an early June interview on Forward Guidance, John Toohig of Raymond James quietly noted that regulators had just begun telling banks to start planning for “higher for longer”.