Federal Reserve Chair Jerome Powell served up the alley-oop and James Bullard delivered the slam dunk. While the latest statement on monetary policy had nothing to say about a hawkish turn at the Fed, Powell served up notice during the press conference. Powell noted growth and inflation prospects that exceeded prior expectations, which in turn forced the Fed’s hand. In case financial markets missed the significance of the tone change, James Bullard, the president and CEO of the Federal Reserve Bank of St. Louis, highlighted the inflation message with his slam dunk.
Jay Powell Served Up the Ball On Inflation
Powell explained that “forecasts from FOMC participants for economic growth this year have been revised up since our March Summary of Economic Projections”. This stronger growth in turn generated larger than expected strains on supply chains. The resulting inflationary pressures caused the FOMC to increase “projections for inflation notably for this year”. Moreover, the Fed acknowledged new upside risks to inflation (emphasis mine):
“As the reopening continues, shifts in demand can be large and rapid, and bottlenecks, hiring difficulties, and other constraints could continue to limit how quickly supply can adjust, raising the possibility that inflation could turn out to be higher and more persistent than we expect“.
Even after serving up this ball on inflation, Powell insisted that “inflation is expected to drop back toward our longer-run goal, and the median inflation projection falls from 3.4 percent this year to 2.1 percent next year and 2.2 percent in 2023”. During the press conference, Powell reassured the audience that this inflation “…is consistent with our goals”. In other words, the Fed does not fear higher inflationary pressures. Instead, the Fed stands ready to address any sudden surge in inflation expectations:
“If we saw signs that the path of inflation or longer-term inflation expectations were moving materially and persistently beyond levels consistent with our goal, we would be prepared to adjust the stance of monetary policy”.
Powell essentially told financial markets that the Fed will not allow inflation to overheat as some pundits and economists fear.
Gold Backed Down
Investors often load up on gold as a hedge on inflation. The plunge in SPDR Gold Trust (GLD) suggests a sudden and sharp decline in inflation fears.
I remain long GLD. In fact, I consider the market’s reaction so extreme, I plan to trade contrary in the coming days and weeks. For example, I will add GLD call options to my core position if GLD retests the March lows.
Even with the Fed’s tone getting more serious about inflation risks, monetary policy will remain extremely accommodative for quite some time. The market’s sharp reactions look like an attempt to take too many steps ahead of a tightening that will not begin until next year at best.
Overall, the Fed did not see anything to change its overall plans or strategy: “…we will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. We expect to maintain an accommodative stance of monetary policy until these employment and inflation outcomes are achieved…More important than any forecast is the fact that, whenever liftoff comes, policy will remain highly accommodative”.
The James Bullard Slam Dunk
James Bullard appeared on CNBC’s Squawk Box two days after the Fed meeting. Various Fed officials typically go “on tour” after a Fed meeting to help financial markets better understand the Fed’s message(s). In the case of Bullard, he placed the squawk of the hawks first. Bullard revealed that “the Chair officially opened the discussion about tapering at this meeting”. Bullard took the opening and drove straight for the hoop with the slam dunk.
He even used the term “hawkish” when referring to the change in messaging (emphasis mine). “The committee has been surprised over the last 6 months: have gone from 4 to 7% GDP growth. 1% to 3% core PCE inflation (3.4% headline inflation is the committee median guess), we’re expecting a good reopening but this is more than expected. So it’s natural that we’ve tilted more hawkish“. I cannot remember a time since the Greenspan era that a Fed official dared to use the term hawkish when referring to monetary policy! Bullard even used the term a second time in the interview when referring to the Fed’s stance against inflation: “3% this year will be ok. 2 1/2 % next year. We will converge to 2% from there. But to do that, we will need to adjust policy some and we’ve already made a somewhat hawkish move here in June”.
Bullard went on to explain that “the inflationary impulse is more intense than we were expecting. There is some upside risk to that as more reopening is ahead. That’s OK. We’re targeting to get inflation above target”. Bullard also noted that reopenings across the globe lay ahead and may deliver additional inflationary pressures.
Of course at some point emergency measures must go away with the emergency. Bullard is quite confident in the Fed’s ability to get out of emergency mode without creating a new economic emergency: “The pandemic is coming to a close here, so it’s very natural that we think about paring back emergency measures. We’re going to do it carefully and thoughtfully. We will do it consistent with a booming economy. We will do it very well”.
Conflicting Messages on Mortgage-Backed Securities?
Bullard answered critics who wonder why the Fed continues emergency measure purchases of mortgage-backed securities (MBS). A red hot housing market features months of soaring prices, large demand pressures, and buckling supply chains. Staying in hawkish mode, Bullard acknowledged that the MBS purchases need to come to an end soon and dared to attach the “B” word to housing.
“Leaning a little bit toward the idea that maybe we don’t need to be in the mortgage-backed securities with a booming housing market, even a threatening housing bubble here according to some people. So, we don’t want to get back in the housing bubble game. That caused us a lot of distress in the 2000s….some people argue there’s not much difference between Treasuries and MBSs anyway. But I would be concerned about feeding into the housing froth that seems to be developing”.
Bullard’s claims may contradict the message from the Fed. The Fed does not explicitly tie its bond or MBS purchases to conditions in the housing market. Instead, overall economic conditions drive these buying decisions. From the press conference (emphasis mine):
“…we are continuing to increase our holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward our maximum-employment and price-stability goals“.
Even if the Fed decided to pay attention to housing prices, it will not see the pricing pressures afflicting so many American markets. On a quarterly basis, the aggregate median price in Q1 2021 was up 5.6% year-over-year. Notably, prices were stable until liquidity flooded the housing market during the pandemic.
Investors in MBS-related markets got the message. For example, AGNC Investment (AGNC) sold off ahead of the Fed meeting. Sellers resumed the pressure the day after the meeting, and I took profits on my own AGNC position.
The Bond Market Celebrated
The bond market was so relieved to hear the Fed is on inflation’s case that it rushed to BUY Treasury bonds. I had my finger on the buying trigger for the iShares 20+ Year Treasury Bond ETF (TLT) ever since the confirmed breakout the previous week. The June 9th September call option trading idea from Fidelity’s In the Money further primed me. I rushed in with a buy as soon as TLT gapped up the day after the Fed meeting. The move from there was astounding. I targeted a test of overhead resistance from the 200DMA for the trade, but the steep and rapid upward push tilts risk/reward toward taking profits in the coming week. Regardless, TLT is a buy on the dips on this breakout.
The sudden reactions in the bond market and financial markets in general surprised me a bit. Friday’s Bullard-driven continuation was startling. Bullard is just the first Fed-head to appear on the speaking tour. He happens to lean hawkish. More dovish members will deliver softer tones. Indeed, Bullard described a debate about the inflation forecast:
“…3% core PCE inflation in 2021, 2.5% in 2022. That would meet the new framework. From there we can bring it down to 2% over the horizon. Other members have different forecasts. This is a debate: will 2021 inflation persist into 2022?”
The market’s definitive move also runs counter to Fed uncertainty and fluidity about monetary policy. From Powell:
“…we really don’t have a template or, you know, any experience of a situation like this. And so I think we have to be humble about our ability to understand the data. It’s not a time to try to reach hard conclusions about the labor market, about inflation, about the path of policy. We need to see more data. We need to be a little bit patient”.
Financial markets are far from patient!
Be careful out there!
Full disclosure: long TLT call options, long GLD