Fed Chairman Debate Gets More Political
Time is running out for President Biden to renominate Jerome Powell as chairman of the Federal Reserve. Hopefully, it will happen soon; according to The Hill, there are enough votes in the Senate to reappoint Powell:
GOP senators, in part driven by concern that a Powell replacement would be more liberal, are making it clear they will help put up the voters to confirm him to a second term. “Most of the people I’ve talked to on the Republican side support his renomination. I can’t think of one person who opposes him,” said Sen. John Kennedy (R-La.). Sen. Chuck Grassley (R-Iowa) said he would support Powell and that he thought there would be enough GOP votes to overcome any Democratic defectors. “The reason I would support him — it isn’t because I agree with the way he’s handled the inflation issue,” Grassley said, “but the alternative would be much worse.” Though nominations only require a simple majority to get confirmed by the Senate, Powell will need help from Republicans as there are likely to be Democratic defections in the evenly split chamber.
It would be ironic, of course, if a Democrat president had to look to Republicans for a key government appointment vote. It would, of course, be good for the country if the Federal Reserve remained in Powell’s hands: the last thing we need now is a pedal-to-the-metal monetary expansion of the kind the MMT-believing radical wing of the Democrat party has in mind. That expansion would be used to fund very large deficits and the far left’s back-breaking spending agenda.
This agenda is often forgotten in the debate over the Federal Reserve leadership. Not only does the left have its so-called Green New Deal that it wants to fully put to work, but they also have major entitlement programs to pursue, among them universal paid family leave, universal tuition-free college and single-payer health care. Raking up a bill of trillions of dollars annually, these programs would come on top of already existing entitlements, not the least of which is Social Security, which could be shifted from its current funding model onto the federal government’s General Fund.
It is this Gargantuan spending agenda that lies behind the debate over Powell’s reappointment. It explains why Powell may be given another term as Fed chairman by fiscally more conservative Republicans, rather than the vocal radicals within the president’s own party.
That is not to say that Powell would be sailing smoothly into his second term. If Biden does reappoint him, his price may be to increase the number of monetary radicals on the Federal Open Market Committee. As the Hill article points out, there can be as many as four seats open there in the near future. If the radicals lose the fight against Powell, they will demand that their candidates be put forward for the other FOMC seats. Their demands will be even stronger if Powell is reappointed with support from a large number of Republican Senators.
Leftist appointees to the FOMC will throw a wrench in any tapering of the Fed’s current, heavily accommodative monetary policy, but the problems for a reappointed Powell won’t stop there. As mentioned, behind the left’s high-pitch rhetoric against Powell is their plan for de facto unlimited deficit spending. It is this prospect of exploding U.S. government debt that makes the sovereign-debt market nervous, and why the Fed is having difficulties even setting the stage for its intended shift in monetary policy. This is painfully visible in the yields on the shortest Treasurys. Figure 1 explains:
The interaction between market expectations and Fed policy is clear:
- This is the decline in short-maturity yields that happened right after Joe Biden was sworn in as president. It coincided with a rise in yields on long-maturity Treasurys, showing how investors fled long-maturity U.S. government debt and flocked to the short-maturity end. This portfolio shift is consistent with an adverse confidence reaction to the debt spending that the Democrats had promised – and are now trying hard to implement. However, while short-term yields plummeted, they remained orderly in the sense that the longer the maturity, the higher the yield: Treasurys of three and six month maturities (blue) paid more than Treasurys of one and three month maturities (red).
- In June, the Federal Reserve raised its rate on reversed repos from zero to 0.05 percent. This effectively increased the floor for Treasury yields, but there are clear signs that the market disagreed with this increase. In order to raise the rate, the Treasury has to push the price of the yield down (yields and market prices always move in opposite directions) which means saturating the sovereign-debt market with securities of said maturity. Since prices have been very high in recent months – pushing yields near zero – this requires a formidable increase in the supply of debt in this market segment.
- As the Fed fights the market to maintain higher yields (likely as a preamble to the coming tightening of money supply) yields of these four short-maturity securities have been jumping around in a way that is completely contrary to what the free market would produce. The volatility appears to be continuing.
While there is turbulence in the short-term end of the maturity spectrum, rates are rising on longer securities. The 20- and 30-year bonds are now parked above two percent; the benchmark 10-year has increased by a quarter of a percent since August and is now paying more than 1.5 percent; the 5- and 7-year bills are above one percent, paying 1.13 and 1.42 percent, respectively, where in early August they paid less than one percent.
The yields on the 5- and 7-year bills are almost exactly what the 20- and 30-year bonds paid a year ago.
Let me repeat that higher yields are equal to lower market prices, which in turn tell us that supply exceeds demand. The Fed has not begun its stimulus tapering yet; when it does, it will technically draw liquidity in from the economy by selling off securities. As it does, prices fall and yields rise – which is what we are seeing now. However, since the tapering has not begun yet, this is the sovereign-debt market acting out the effects of a tapering, before it has even begun.
There is really only one plausible explanation for this: investors in U.S. debt are worried that Powell will not get reappointed and that if he is, he will be accompanied on the FOMC by MMT proponents. Once the Fed begins rolling back its monetary expansion, it will ease the concerns that the market has. At the same time, heightened political tensions over FOMC appointments will most certainly rattle the market and contribute to a faster rise in interest rates.