Since the Zoltan Pozsar challenged Federal Reserve Chair Jerome Powell to find his inner Paul Volcker and raise interest rates high enough to bring the inflation expectations to heel. (He argued draining liquidity and raising rates to a NEUTRAL level OUGHT to be the medicine needed to truly render the current high inflation levels TRANSITORY.) Last week, Pozsar pushed on the theme again with a piece titled, “Ride of the ‘Volkyries'” in which the issue of financial conditions tightening is discussed in reflection to current FED policy of curbing inflation through the crushing of demand.
As Pozsar wrote: “The FED appears to have chosen price stability as the priority: it wants slower growth and higher unemployment; further, tighter financial conditions mean some financial instability by definition — nothing systemic, but turmoil still.”
This is the constant in what the FED is attempting to do: Crush U.S. consumer demand through the TIGHTENING OF FINANCIAL CONDITIONS because it is by Powell’s own admittance that it’s the only tool available as it cannot by waving a wand increase supply of computer chips, autos, energy or any other good. The Bernanke FED was concerned with idea of disinflation and asset liquidation, which is why it created a portfolio balance channel that used massive amounts of liquidity to elevate personal wealth. As I noted in the last blog post, Powell is tasked with the opposite.
The problem for Powell is that in seeking his inner-Volcker against the current economic backdrop would even stymie Volcker. During his tenure at the Federal Reserve from 1979-1987, public and private debt levels were substantially lower, which allowed Volcker to press harder on the monetary breaks without sending the U.S. economy into a depression. (Financing the debt at 20% would’ve tightened financial conditions to a level that crashed the global economy.) The preponderance of debt makes Powell’s task much more difficult, which is why we will continue to hear the cry about tightening financial conditions.
On Thursday, Treasury Secretary Janet Yellen joined the conversation on financial conditions by discussing the concerns caused by a strengthening DOLLAR. While at the G-7 conclave in Bonn, Germany, Yellen said, “From the standpoint of the administration, we’re committed to a market-determined exchange rate.” (NOTE: One of my regular readers said this is laughable because why don’t they believe in market-determined BOND RATES?) Yellen added, “There are many countries with dollar-denominated debt, and a rising dollar makes it more difficult for countries to bear that debt. We know that often emerging markets worry about how they will fare in an environment of higher interest rates and tightening monetary policy.”
THIS IS THE FIRST TIME THE WHITE HOUSE HAS NOTED THE NEGATIVE ASPECT OF TIGHTENING FINANCIAL CONDITIONS. This suggests that there was much concern about the stress from a financial world loaded with dollar-denominated debt. While I criticize Powell for not engaging on this issue I know it is the Treasury’s bailiwick. While headline inflation is a domestic policy concern the systemic stress from a rapidly rising DOLLAR is a systemic financial concern. Would heightened tightening of financial conditions due to massive losses in global bond and equity markets slow the FED or force them to reach for other deals? Listen to all statements coming from the G-7. In dealing with its allies on the Ukraine invasion and sanctioning of Russia, the U.S. is asking a great deal. Will the White House listen to its friend in need of relief form financial stress?