Powell Positions Fed for Mid-Year Start to QT2

Here are my key takeaways from Chair Powell confirmation hearings:

1. Questions from Democratic senators on inflation suggest a bi-partisan consensus in support of Fed hawkishness.
2. Chair Powell expects the impact from omicron to be short lived: ‘I think it is likely Omicron is going to go through really quickly and peak, perhaps within a month and then come down after that. It’s likely you will see a pause in growth, but it should be short-lived. And then the forecast for the rest of the year would be a very positive one.’
3. Supply bottlenecks are going to be a key driver of Fed policy. When asked by Pat Toomey how he expected inflation to come down with a negative end 2022 real FF rate (the Dec. SEP shows 2022 FF at 0.9 and PCE at 2.6%) Powell answered: ‘we do think we’ll get over the course of this year return to normal supply conditions’ and implied that if not the Fed would hike further.  The Fed has recently published 2 notes quantifying the impact of bottlenecks but no regularly updated index like the Common Inflation Expectations index.  Still, I will be monitoring their view on this topic. (Notes: ‘Quantifying Bottlenecks in Manufacturing’ and ‘Effects of Supply Chain Bottlenecks on Prices using Textual Analysis’)
4. Powell declined to answer a question on whether the Fed could have a faster taper in lieu of a hike but I think this is more likely because he has not reached internal consensus (KC Fed president George could be pushing in that direction) than because this is a serious possibility. The Dec. minutes stated clearly that the main policy instrument of the Fed remains the FF rate, and in any event the taper ends in 2 months.
5. Powell’s statement was roughly in line with my mid-year QT2 start expectations.  Powell said ‘sooner and faster’ for QT2 relative to QT1 while stressing that ‘his balance sheet is much shorter in duration than the one that we had at the end of the Global Financial Crisis’.  He added that the Fed would need 2 to 4 meetings to finalize QT i.e. details would be agreed to around mid-year: ‘We tend to take two, three, four meetings to work these things through.’ This is consistent with the minutes statement that QT would be finalized in ‘coming meetings’. The Fed is also likely to start slow, based on Chair Powell’s tentative tone – ‘perhaps later this year, depending on the run of things. We would also see ourselves beginning to allow the balance sheet to shrink.’
6. Powell also implies that securities sales (as opposed to non-reinvestment) were unlikely – ‘In terms of selling assets, we haven’t made any decisions on that. We didn’t do that last time. We never ruled it out either.’

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

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