The Federal Reserve is causing some consternation in financial circles both for its monetary policy decisions and for its regulatory actions.
It seems many investors are just now catching on to the implications of the Fed’s shift in its attitude towards inflation—not coincidentally because real inflation is once again becoming a possibility.
Markets have been asking the Fed to give them a signal on its intentions by pushing up yields on U.S. Treasuries and investors have been a bit shocked as policymakers say that other things, like employment, have priority.
But then on the regulatory front, the Fed is ending COVID-19 relief on capital requirements that directly counters their efforts on monetary policy.
The central bank announced last week that it will let the exemption on requirements for the supplementary leverage ratio expire on schedule on Mar. 31. The industry had been lobbying to extend the exemption and was confident this would happen, given the Fed’s super-accommodative monetary stance.
The exemption allowed banks not to count Treasury holdings or reserves as assets in determining the ratio, which allowed them to take more deposits and make more loans.
The Fed says it will be reviewing the ratio, hinting that it might be changed permanently. But if that is the case, why not extend the temporary exemption?
Unmoored Fed Policy?
It doesn’t make a lot of sense to the man on the Street. As numerous commentators have pointed out, that move contradicts the Fed’s push for greater employment because it will force banks at some point to contract their activity.
Moreover, it even contradicts safety and soundness concerns because if riskless assets like Treasuries and central bank deposits count the same as high-risk assets, why not go for the higher return?
Fed policymakers talk a lot about anchoring inflation expectations, but it is Fed policy that seems to have come unmoored. Some analysts are even talking about a regime change.
You don’t have to look too far to see why the Fed has shifted its priorities. Two progressive Democratic senators, Banking Committee Chairman Sherrod Brown of Ohio and committee member Elizabeth Warren of Massachusetts, have it in for banks and have publicly opposed extending the exemption.
It is bad enough that government regulatory agencies like the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation let the senators call the tune, but when a supposedly independent Fed—which is the main regulator for big banks—falls in line without a peep, that is cause for worry.
Sometime this year, US President Joseph Biden will decide whether to reappoint Jerome Powell as chairman of the Fed, so there is a growing perception that Powell wants to at least avoid rocking the boat unnecessarily.
Fed governor Lael Brainard, the only board member affiliated with Democrats, is poised in the wings to take over as chairperson after having dutifully accepted someone else—her old boss, Janet Yellen—becoming Treasury secretary.
The Federal Open Market Committee left monetary policy unchanged at its meeting last week, as expected, and Powell reaffirmed the Fed’s commitment to keep the monetary spigots open for the foreseeable future—also as expected.
Powell repeatedly emphasized, under questioning, that inflation will have to exceed the Fed’s 2% target on more than just a transitory basis to get policymakers to consider possible action on interest rates. This of course begs the question as to how high or how long inflation would have to exceed 2%.
He also repeatedly downplayed the importance of the members’ forecasts for inflation or interest rates in the Summary of Economic Projections, pointing out they are individual forecasts, not a consensus reached by discussion or debate.
Yield on the benchmark 10-year Treasury note ended the week up nearly 10 basis points after the FOMC meeting and the announcement on capital ratios, closing the week at about 1.73%.
Powell will testify twice to Congress this coming week, alongside Yellen, on COVID relief and will also speak at a Bank for International Settlements event. Several other FOMC members will be speaking, including Fed Vice Chair Richard Clarida, Vice Chair for Regulation Randal Quarles, Brainard, and New York Fed President John Williams.
Presumably they will all be at pains to clarify Fed policy, but they are highly unlikely to dispel investor confusion as they will be constrained from being specific about targets on inflation and rates.