DEDUCED RECKONING: Jerome Powell’s Fed steps up to 'keep prices in check'

This week Federal Reserve Chairman Jerome Powell has been appearing before the U.S. Senate Banking Committee with regard to his reappointment to another four-year term by President Joe Biden. There is no question he will be approved for reappointment but he has been on the hot seat this week answering questions about the economy and inflation.

When COVID began rolling across the world in March 2020, President Donald Trump moved to shut down America in an attempt to curtail the spread of the disease. Never before in our history had someone simply turned off the economy. Investors were terrified at the prospect. In a brief three-week period of time, stocks dropped by 38%. Every asset class collapsed when there were simply no bids for anything anyone wanted to sell.

To his credit, Powell's Fed moved swiftly on several fronts. They cut interest rates to near zero and made clear they would keep them there for as long as necessary. Then the Fed began pumping $120 billion per month into a variety of asset classes. They bought stocks, bonds and mortgages. In no time flat, the Fed’s own balance sheet swelled to an unprecedented $5 trillion.

The goal was to “reflate” assets and consumer confidence. They succeeded by inflating prices of homes and investment securities to record levels. Nationally, housing prices are up about 18% from December 2020 to December 2021. While staying at home, some chose to turn the stock market into a big game. Companies with no earnings now or for the foreseeable future are selling for 100x losses. The only way you exit investments like that with a gain is if a bigger fool takes you out of your position.

Suddenly, consumers have become alarmed about price increases for just about everything they buy. The average price of a used car has surged to $29,000 due to a chip shortage curtailing deliveries of new vehicles. Supply chains are disrupted so what is available is very expensive. In order to attract frontline workers back to airlines, restaurants or any place where they must interface with the public, wages are rising sharply.

Until recently, Powell kept insisting that inflation was transitory. Now he has changed his tune. The Fed is going to rapidly remove the punch bowl of $120 billion/month money pumping and will reduce that to zero within the next 3-4 months. They will also begin raising interest rates faster than previously expected. That will immediately crimp the housing market as mortgage rates rise.

In December the expectation was they would raise rates starting in mid-year. Now the Fed members are speaking about raising sooner and maybe 4-8 times this year. If they take rates up at ¼% each time, that could put rates at 2.50% by year end.

In his testimony on Tuesday, Powell assured investors that “We will keep prices in check.” He was referring to inflation. But be aware that will have the same chilling impact on stock prices. His comments at face value might have led to a relief rally for tech stocks with no earnings. It is not likely to persist. As rates rise, infatuation with companies with no earnings will continue to fade.

The infrastructure bill has been passed. Build Back Better is still being negotiated. JPMorgan’s Jamie Dimon thinks the consumer is in the best shape he has been in since perhaps the Depression. But omicron has exploded from coast to coast and remains an unknown variable in its impact. By its new aggressive actions, the Fed is pushing investors away from inflated stock prices and toward companies that offer value. Once it is safe to be outside again, there will be some opportunities for solid companies to really prosper.

Joan Lappin CFA has been called an “investment guru” by Business Week and a “top manager” by the Wall Street Journal. The Sarasota resident founded Gramercy Capital Management, a registered investment adviser, in 1986. Email her at JLappincfa@gmail.com. Follow her on twitter: @joanlappin. Her past columns appear at heraldtribune.com/business/columns.