Sen. Elizabeth Warren (D-Mass.) wants to oust Jerome Powell. Last week she went after the Federal Reserve chair, saying in an interview on NBC’s “Meet the Press”: “My views on Jay Powell are well-known at this point. He has had two jobs. One is to deal with monetary policy. One is to deal with regulation. He has failed at both.”
It is hard to disagree with the Massachusetts senator, though Powell is certainly not the only one responsible for bringing us to the brink of recession. Democrats recklessly spent too much, heedless of the overheating economy, Treasury Secretary Janet Yellen has been AWOL throughout; and bank supervisors did a lousy job preventing problems even as alarm bells rang.
But Powell is in the driver’s seat and is coming under increased scrutiny. Democrats, worried that a recession could hurt them badly in the elections of 2024, need a scapegoat. But it’s not just Democrats who are critical of Powell’s actions.
Ed Hyman, Wall Street’s top economist and a generally optimistic fellow, wrote clients a cryptic message last week titled: “Not Good.” His email alert came the day after Powell announced another rate hike, of 25 basis points.
Hyman called three aspects of Powell’s decision “unprecedented.”
- That the Fed hiked rates amid a financial crisis;
- that it did so even though the interest rate curve was steeply inverted;
- and that it increased interest rates even though the money supply (M2) is shrinking.
When seasoned economists or investors tell us something is unprecedented, we should pay attention. There’s probably a reason no one has walked that road before; sometimes it’s a good reason.
Hyman’s concerns are that the Fed is going too far and too fast in trying to squelch inflation, and that its actions may drive the economy into a ditch. Hyman is certainly not alone. Several analysts predicted before the Fed meeting that in light of the failures of Silicon Valley Bank and Signature Bank, and the uncertainty over Credit Suisse and others, Powell and the board would pause rate hikes, assessing the system as too fragile to press harder.
That didn’t happen because Powell has gotten himself in a box. For several months he has tried to convince Wall Street that he means business and will pursue his anti-inflation rate hikes no matter what. For months, Wall Street has ignored him.
In February, Powell talked tough but raised rates only 25 basis points, and used the word “disinflationary,” referring to signs of price moderation in some sectors. Though allowing some optimism, Powell also said the battle against rising prices would require “maintaining a restrictive stance for some time.”
Investors ignored his cautions and tipped off a strong two-day rally, convinced the inflation fight was nearly over and that rates might start to drop by year-end.
Fast forward to the most recent Fed meeting. Investors were expecting a 25-basis point hike, and Powell, who generally appears loath to rattle markets, delivered. To do otherwise would likely have signaled concern about the health of the banking system. Investors would have wondered, given Powell’s stated commitment that fighting inflation comes first, what does he know that we don’t know?
Still, according to Hyman and others, it was a bad choice. First, because monetary policy works with a lag of a year or more. The Fed started raising rates last year in March; that process should only now begin to impact economic activity. Indeed, some indicators, like declining durable goods orders and a downturn in manufacturing, suggest we are entering recession territory now.
Not only has the Fed been raising interest rates for a year, but it has also done so more aggressively – i.e. with sharper hikes –than at any time in recent history. In addition, it has pushed up the cost of borrowing while shrinking its balance sheet. That’s powerful medicine.
There have indeed been signs that inflation is cooling. The headline Consumer Price Index has dropped sharply from its 9.1 percent peak last June. Shipping rates have decreased, rents have declined in many cities and oil prices are way off their peak. Bloomberg’s commodity index has drifted steadily lower and is down about 30 percent from its top, and wage growth, though still too high, has declined even as the labor market remains robust.
Chair Powell mentioned in his recent press conference that concerns about bank safety would lead to a constriction of credit, which could also slow the economy. One survey indicates that it is already harder to get a car loan, which may be the tip of the iceberg. Add to that signs that consumer spending is beginning to falter, and the outlook for the balance of the year darkens.
Powell is right to try to stomp out inflation, but he deserves blame for bringing us to the brink of recession.
Perhaps because he feared not being reappointed for another four-year term, Powell stalled, even as inflation soared to 40-year highs. Having waited too long, he then applied the brakes so aggressively that banks lost huge amounts of money on their holdings, and some failed.
If the economy turns down, the White House may decide that Powell must take the fall. It could ask for his resignation. Replacing Powell with a dedicated dove, such as Fed Vice Chair Lael Brainard, would be a disaster; investors would lose confidence in the battle against inflation.
The political pressure on Powell henceforward will be intense. Realistically, driving inflation down to 2 percent is likely not achievable; we might have to endure a deep recession to get there. Powell will almost surely redefine his target in coming months and admit that we should live with 3 percent – 3.5 percent inflation.
Is that a good outcome? No. History tells us the next wave of inflation could be even more punishing. But it could save Powell’s job.
Liz Peek is a former partner of major bracket Wall Street firm Wertheim & Company. Follow her on Twitter @lizpeek.