Traders brace for Jerome Powell’s next move after taper shock

Jerome Powell’s tenure as Federal Reserve chairman has always been a balancing act.

The Republican from Maryland was nominated to the board of the world’s most important central bank by Barack Obama in 2012, promoted to its top job by Donald Trump in 2018 and reappointed last month by Joe Biden.

He has worn many guises. On making his first statement as chairman, markets were unsure what they were dealing with – a hawk or a dove?

On Tuesday Powell flipped his stance yet again, ditching the central bank’s mantra that inflation is ‘transitory’ and floating the possibility of quicker policy tightening. It sent a shock wave through markets, forcing investors to reassess their reliance on the Fed’s largesse and raising questions over whether Biden understood what he was signing up for in asking Powell to remain.

During Trump’s years, the 68-year-old fell into the hawk camp almost by default as he was forced to shoulder White House pressure to cut the cost of borrowing, which tends to stimulate lending and boost stock valuations.

But in late 2018, he dramatically turned dove after sparking a rout known as the “Christmas Eve massacre” by signalling the Fed would try to cut down its balance sheet. It was known as the (first) ‘Powell pivot’. Since then the benchmark S&P 500 stock index has almost doubled, buoyed by the twin investment drivers of FOMO (fear of missing out) and TINA (there is no alternative).

Coronavirus accelerated those plans, with Powell overseeing a rapid slashing of rates and huge expansion of the Fed’s bond-buying efforts, which have helped inject markets with steady, uncompetitive capital throughout the pandemic.

Remarkably he has garnered support from a variety of corners: those on the left credit him with helping to support the labour market through a period of turmoil, while speculative retail investors revere the man they believe makes stocks always go up.

He has also become a living meme. The “money printer go brrrrrrr” mantra is used online to pithily summarise the Fed’s bond-buying, while the “Powell put” denotes investing on expectation that if faced with economic problems, the Fed will step in.

The chairman has held firm in his stance in recent months as the Fed received pushback against a post-pandemic wave of inflation that proved stronger and more sustained than feared.

He became the de facto figurehead and steadfast spokesperson of ‘Team Transitory’, the moniker given to those who said the supply-related problems pushing prices higher would dissipate in the coming months. To do so, he had to manage a divided committee where, as Grant Thornton chief US economist Diane Swonk puts it, “hawks rule the roost”.

It almost wasn’t enough. As the Biden administration debated whether to keep Powell in post, the most serious alternative – Lael Brainard, who will now become the next vice-chairman – was even more dovish.

But inflation has become a major concern for the Democrats and its senators are said to have privately grilled Powell over what he would do to rein in price increases.

He was also criticised by Senator Elizabeth Warren, the former presidential hopeful and major voice on financial regulation, who called Powell a “dangerous man to head up the Fed”.

“Renominating you means gambling that, for the next five years, a Republican majority at the Federal Reserve, with a Republican chair who has regularly voted to deregulate Wall Street, won’t drive this economy over a financial cliff again,” she told him at an October hearing.

Having weathered that storm – and with signs that commodity prices are finally beginning to ease – Powell might have felt he could finally relax at Tuesday’s hearing with the Senate Banking Committee.

Sitting alongside his predecessor Janet Yellen, the chairman faced a conventional string of questions about policy - albeit with an omicron twist.

Unexpectedly, he pivoted. Answering a question on inflation, he took the opportunity to “retire” the word “transitory”, warned the Fed may “taper” its bond-buying efforts sooner than previously indicated and even hinted rate rises may eventually be needed.

“It is appropriate, I think, for us to discuss at our next meeting, which is in a couple of weeks, whether it will be appropriate to wrap up our purchases a few months earlier,” he said. “In those two weeks we are going to get more data and learn more about the new variant.”

After three years of investments made safe by Fed support, markets were caught flat-footed. Stocks fell sharply.

A spoof video that showed Powell sucking dollar bills back into a printer received tens of thousands of ‘upvotes’ - a signal of support - on Reddit forum WallStreetBets, a million-strong hive of retail investors.

Krishna Guha, vice-chairman of banking advisory firm Evercore, says the “jarring adjustment” on markets reflected surprise at the strength of Powell’s signalling.

“Powell could live to regret being so forward-leaning at a moment when uncertainty relating to the pandemic and its impact on the economy has increased again sharply, and might have adopted a slightly more nuanced position given how much we may learn in the days ahead”.

Elisabet Kopelman from lender SEB says the market reaction seemed premature, adding: “Powell’s comments were mainly about lifting the foot of the gas pedal earlier and there was no talk about tighter policy.”

His apparent shift may prompt recriminations within the Democratic Party. Progressives, who fought against his re-appointment, will fear that unhooking the US’s monetary drip could send fresh shockwaves through its economy.

Biden may feel satisfied or betrayed, depending on what Powell promised in the lead-up to the decision.

Wall Street bounced back early on Wednesday but ended the session lower. Powell may have spooked traders but the short-term issues – concerns over labour market recovery and if Omicron will prompt new lockdowns – haven’t changed.

Yet going forward, traders might be a little less confident that they know what the man in charge of America’s money will do next – for better or for worse.

“He just did basically a flip-flop in the last month,” Tony Dwyer of Canaccord Genuity told CNBC. “So who’s to say that can’t happen again next year?”