by Mitch Kokai
Senior Political Analyst, John Locke Foundation
Investors appear confident that the status quo of ever-so-slow monetary tightening will continue at the Federal Reserve when Jerome Powell takes over from Janet Yellen in February.
But some observers see complacency in that stance. “What the markets are clearly ignoring at this point is that policy continuity is not a static phenomenon; it’s a trend,” says Lena Komileva, chief economist at G+ Economics. “And the trend is toward reduced policy stimulus from the Fed at a time when the economy is at full capacity and is showing signs of boiling over.”
While two-year yields have risen, the yield curve has flattened, thanks to a range-bound 10-year Treasury yield, which pulled back from a seven-month high above 2.48%, after it became clear that Powell, a Fed governor, would be President Donald Trump’s nominee, rather than a more hawkish candidate, such as Stanford University economist John Taylor. Economists cite low inflation and strong overseas demand as factors keeping long-dated yields in check. …
… Markets have tended to test new Fed chiefs early in their tenure on their willingness to hike rates and restrain inflation, says Steven Ricchiuto, chief U.S. economist at Mizuho Securities. And while he describes Powell as the “safe choice,” he doesn’t think his experience will be any different.
Ricchiuto sees the potential for an inflation spike early next year, as energy and health-care prices rise. That could prompt hawkish remarks by Powell during his semiannual testimony to Congress in February; a March rate rise could follow. That, in turn, could result in a further flattening of the yield curve as short-term rates climb, a scenario not generally viewed as positive for the economy or the financial markets.
Shepherdson also predicts that, by the time most new Fed members take their seats, “the data will point the Fed unambiguously toward higher rates. Mr. Trump’s appointees won’t be able to hold back the tide.”