Wednesday's Market Minute: 4 Trillion Reasons Jay Powell Will Turn Hawkish

The most important thing happening in America outside the COVID situation is the Biden administration’s effort to pass $4 trillion of spending. There is division among the President’s party about if and how to pass the two pieces of this grand sum – a $500 billion pure infrastructure bill, vs another $3.5 trillion encompassing a range of subjects from environmental to social programs. If you read any story about why there’s division on the subject, it comes down to one factor: inflation.

Here’s Bloomberg’s headline from Aug. 11: “Biden Says His $3.5 Trillion Spending Plan Won’t Stoke Inflation.” Yeah, it’s on his mind. The President has specifically mentioned it on numerous occasions. Politicians are doing TikTok videos about CPI. It’s on everyone’s mind.

Inflation is the quickest surefire way to kill Biden’s legacy before it’s even started. It’s the only observable risk to the economy outside of COVID, and it would be totally inexcusable to let it run amok. It’s one thing to get blindsided by a crisis – it’s another to ignore the warnings and walk right into one. That’s irrecoverable.

Rest assured the administration will do everything it can to make sure that doesn’t happen.

The good news, at this juncture, is that their position need not be an overly complicated one to hedge. The bad news is that the market is not ready for anything but pure nirvana.

There’s an obvious middle ground: the Fed stands by its word to not hike rates, but starts unwinding its asset-purchase program at a rate commensurate to satisfy the hawks. That means starting in December at the very latest.

There’s non-negligible reason to believe Powell may be susceptible to political pressure. The Fed Chair’s most dramatic about-face of his career thus far was his choice to end rate hikes going into 2019. Yes, the stock market was down, and there were imperfections within the economy; the market was giving him feedback that maybe the hikes were too much. But it’s impossible to ignore the other feedback he was getting: President Trump’s incessant haranguing of Powell in the public sphere about needing to cut rates.

All these things culminated in a full-blown rate-cutting paradigm in 2019 whose necessity should rightly be debated, given financial conditions had loosened to the most accommodative on record at the time of an interest rate cut. The move was extreme.

Jerome Powell today is convincing in his commitment to an economic philosophy that the Fed should play as minimal a role as possible until employment reaches levels of inclusion that are unprecedented by American standards. It’s a goal we can all get behind. Yet we don’t know precisely how possible it is in this juncture, so it behooves the Decision-Making Powers to hedge this historically unique bet, and test the market’s appetite for change.

The transitory argument is compelling on the basis of last year’s comparables, but it’s impossible to know where the annual rate will plateau on the way down. With stocks trading at valuations second only to the most extreme moments in the dot-com bubble, and people spending hundreds of thousands of dollars on rock JPEGs, Powell knows as clear as the hairiest bear on the street the craziness that he’s dealing with.

By hedging his bet, everyone wins. Except the people buying rocks.