The longer US asset bubbles are allowed to fester and grow, the more Asia will look to the Fed with skepticism rather than trust
https://asiatimes.com-by William Pesek
Federal Reserve Chair Jerome Powell has been given a second term. Photo: AFP / Al Drago
TOKYO – Is Jerome Powell the best man for the worst job in global finance? That’s US President Joe Biden’s take as he gives Powell a second term as Federal Reserve chairman.
Yet the real question, and the one that might matter the most, is: How is Asia placed for four more years of Powell’s leadership?
For sure, the appointment ends the suspense that has distracted markets in recent weeks. Biden had been toying with the idea of replacing Powell with Lael Brainard, a Fed governor who’s known to be even more dovish policy-wise.
This decision, for better or worse, removes the uncertainty factor. Asia, though, might not relish the idea of the Powell era getting more room to roam.
Firstly, Powell is a political pushover. Since 2017, the Fed’s long-cherished independence from legislative meddling was, well, trumped. In February 2017, then-US president Donald Trump replaced then-Fed chief Janet Yellen with a non-economist, a first in more than 40 years at the world’s most powerful central bank.
At the time, Powell was serving as a Fed governor. A lawyer by training, Powell had worked in investment banking, including at private equity giant the Carlyle Group.
In 2012, Powell became one of those iconoclastic policymakers sometimes added to the Fed – someone with on-the-ground experience in finance and banking. Here, think banker Edward Kelley, a Ronald Reagan appointee who served on the Fed board from 1987 to 2001.
Powell, though, was no match for Trump’s bullying. In her 2014 to 2018 stint as Fed chair, Yellen worked to normalize Lehman Brothers-era emergency policies. In December 2015, the Yellen Fed began putting actual rate hikes on the books.
Early on, Powell continued that tightening – until Trump publicly threatened to fire him. The Fed pivoted back to rate-cut mode.
Then 2020 and Covid-19 hit, pushing the Fed down the quantitative easing rabbit hole more swiftly and deeper than ever before. The Fed’s excess liquidity isn’t just fueling asset froth in the US but in Asia, too.
That loose cash is zooming toward bourses in Tokyo, Singapore and Hong Kong. While investors may be happy, all those dollars sloshing around are warping economic incentives. And putting Asia’s nearly US$4 trillion of US Treasury debt holdings at risk.
Asia, it’s often said, is Washington’s main banker.
Lisa Shalett, the chief investment officer of Morgan Stanley Wealth Management, speaks for many when she warns that “all-time low negative real rates are apt to create excesses and poor future returns. We are concerned that Fed policy is divorced from the fundamentals.”
As Shalett notes, the difference between the Fed-funds rate and the US Consumer Price Index is by some measures the most worrisome ever. “The gap is the widest in the 60-year history of the inflation gauge,” she says.
The bloated – and bloating – Fed
A second issue that worries Asia is that the Fed has become too big to control.
It might sound odd to suggest Powell is politically captured, but also difficult to rein in. The reference here is really to the Fed’s $5 trillion-plus balance sheet – an economic Frankenstein of sorts.
The Bank of Japan knows quite a bit about how a monetary monster policymakers create could go awry and come back to harm its creator. Powell is now finding that pushing into myriad asset classes is one thing, but exiting is quite another.
If Powell goes overboard in trying to “taper,” markets might crater and politicians, corporate CEOs, bankers and investors alike would howl in protest.
The so-called bond vigilantes, meantime, would pounce in ways that drive up US debt yields and slam the dollar. As these are the linchpins of the global financial and trading systems – and the center of Asia’s export-driven economies – it’s quite a risk.
One likely reason why Biden is sticking with Powell is fear. In the Covid age, managing economies can feel like a giant and precarious game of Jenga. Removing any one block at the wrong moment risks everything coming crashing down.
With US inflation surging and his approval ratings falling, Biden may have simply decided not to touch the Powell piece of the game.
Strategist Kathy Jones at Charles Schwab calls it a “don’t-rock-the-boat move.” Adds economist Mark Zandi at Moody’s Analytics: Biden “chose the status quo for monetary policy and financial regulation. The Fed is going to slowly but steadily take its foot off the monetary accelerator.”
Yet this also means the Fed remaining on something approaching policy autopilot. All Asian markets can do is hope the Fed can eventually land the monetary plane.
“The Powell renomination,” says analyst Jeffrey Halley at OANDA, “put the Fed taper trade front and center once again overnight, with markets quickly moving to price in a first 0.25% hike by mid-2022 and long-dated US yields rising sharply.”
Yet sharp and unforeseen rate increases do not seem on the cards for now.
Fat Fed breeds bad pols
A third reason why Asia is all a quiver is that the Fed will continue enabling bad politicians.
The lesson from Japan is that central banks must be careful not to make life too easy on elected officials. A key reason why a revolving door of governments spent the last 20 years punting bold reforms forward is because the BOJ had their backs.
After all, why risk pulling out Jenga pieces when you can just prod the central bank to ease more, and up government spending a bit?
The tribal nature of US politics is gridlock-inducing. That means that the US Congress might fire off the odd spending package, but bold steps to increase competitiveness and innovation will be few and far between.
That leaves Powell’s Fed in the driver’s seat for the foreseeable future, if not taking on an even bigger role.
The upshot is that steps Congress might’ve been forced to take to strengthen Washington’s balance sheet will fall by the wayside. Hanging in the balance are some very, very big metrics: faith in the dollar; the stability of US government debt; and the outlook for Asian growth in 2022.
Had Biden gone with Brainard as the new Fed chairman – he nominated her as Powell’s No 2 – Asian markets might worry about even more aggressive US monetary policy. Even so, any suggestion that Powell might be a hawkish Fed leader is belied by his track record.
As economist Seth Carpenter at Morgan Stanley points out: “Powell has stressed, and in our view will continue to stress, that the conditions for tapering are different from the conditions for a rate hike. If our forecast is realized, then declining inflation over the course of 2022 combined with a sustained rise in the labor force participation rate will mean that inflation by itself will not trigger a hike.”
Yet the longer US asset bubbles are allowed to fester – or increase in size – the more Asia will be looking to Washington with more skepticism than trust.