A sober Jay Powell on Wednesday delivered a message that spooked markets while serving an important purpose.
The chairman of the Federal Reserve said the US recovery from the deep downturn inflicted by the pandemic had slowed due to a resurgence of the virus and a return to normal was still far away for the world’s largest economy.
But his gloomy stance reinforced the Fed’s dogged determination to keep pumping massive amounts of monetary stimulus into the economy, stamping out suggestions that the US central bank might start removing, or “tapering”, support by reducing the scale of its asset purchases any time soon.
“[Mr Powell’s] mission was to dispel the notion of any early taper, but in order to do that and justify dispelling the notion of early tapering, he also had to comment on the state of the economy and take a cautious tone,” said Jim Caron, a portfolio manager at Morgan Stanley Investment Management. “That added to the already negative sentiment in the market and exacerbated the downside.”
US stocks notched their worst day of the year on Wednesday, with the losses accelerating as Mr Powell spoke. The benchmark S&P 500 closed lower by nearly 3 per cent, its largest drop since October.
“No matter what, it is a Catch-22,” added Mr Caron. “If Powell came out way too optimistic, equity markets may have sold off even more because now interest rates may be going up sooner and that is going to be even worse.”
The Fed articulated its downbeat view of the short-term outlook by acknowledging the recent slump in some economic indicators, something it did not do in its December statement.
“The pace of the recovery in economic activity and employment has moderated in recent months, with weakness concentrated in the sectors most adversely affected by the pandemic,” the Fed said.
Mr Powell then amplified that assessment during his press conference.
“The economy is a long way from our employment and inflation goals, and is likely to take some time for substantial further progress to be achieved,” he said, adding that it was going to be a “struggle” to defeat the pandemic by reaching herd immunity through vaccinations.
“We have not won this yet, we haven’t succeeded in doing this yet, and we need to stay focused on it as a country,” he said.
The central bank had entered tricky terrain at the beginning of the month after a handful of Fed presidents speculated about the prospects of the Fed beginning to wind down its $120bn monthly asset purchase programme as early as this year.
The comments jolted complacent investors, who had pencilled in a 2022 retreat, and rekindled painful memories of the 2013 “taper tantrum” that caused a sharp jump in Treasury yields and dramatic tightening of financial conditions around the world.
Mr Powell addressed this directly too, saying any talk of tapering was “premature” and pledged that any plans to consider an exit strategy would be clearly communicated well in advance.
“[Tapering] is going to be super well-telegraphed,” said Chris McReynolds, head of US inflation trading at Barclays. “They really have no interest in surprising the markets.”
Krishna Guha of Evercore ISI noted that Mr Powell also made clear that the Fed would avoid using monetary policy to stamp out any asset price bubbles, after being pressed on signs of frothy market valuations during the press conference.
“He resolutely refused to be distracted from the Fed’s core macroeconomic goals by what is going on in the casino end of the stock market,” Mr Guha said. “They’re keeping their eyes on the prize”.
One bright spot was Mr Powell’s insistence that the biggest economic risks were near-term, suggesting confidence in an economic pick-up in the second half of the year. But the Fed chairman made clear that the central bank would not overreact to any quick improvement, even if it involved a sudden inflation spike.
“Frankly we welcome slightly higher, somewhat higher inflation. The kind of troubling inflation people like me grew up with seems unlikely in the domestic and global context we’ve been in for some time,” he said.
Mr McReynolds said he believed the Fed would be “true to their word, and let things run hot”.
However, the Fed chair did not entirely dismiss the likelihood that once the recovery was complete, there could still be some structural damage to the economy, or at least dislocations that may have to be addressed by policymakers.
“We’re learning that technology can replace people even more than we thought. As we get into the phase, even after the economy fully reopens, I think we’re still going to need to keep people in mind whose lives have been disrupted,” he said.