Powell Faces Fiscal, Macro Policy Potpourri

Update 516 — Support for Recovery (Act)?
Powell Faces Fiscal, Macro Policy Potpourri

Federal Reserve Chair Powell and Treasury Secretary Yellen both appeared before the House Financial Services (HFSC) yesterday and Senate Banking today. The main takeaway from them: the economic recovery needs additional federal support. 

The ARP will boost the economy and the Fed projects the highest annual growth rate in 40 years, 6.5 percent, for 2021. So why the bigger package in Biden’s kitchen? Why not fear inflation? We look at the answers in Powell’s testimony, as well as Yellen’s, and examine recent developments at the Fed including relevant regulation and monetary policy discussions during the hearings.

Best,

Dana

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Powell’s Economic Outlook

“The recovery has progressed more quickly than generally expected and looks to be strengthening,” Powell noted in his prepared testimony before the HFSC on Tuesday. Last week, the Federal Open Market Committee (FOMC) ramped up its economic growth expectations in part due to the passage of President Biden’s $1.9 trillion American Rescue Plan (ARP) and better-than-expected vaccine rollout. The FOMC now expects GDP to grow by 6.5 percent — up from its 4.2 percent forecast from December — and unemployment to drop to 4.5 percent in 2021. 

The FOMC also adjusted its inflation expectations for this year, increasing its forecast from 1.8 percent to 2.2 percent. The new economic forecast alongside the ARP’s passage prompted Republican members of the HFSC and Senate Banking Committee to express concern about rising prices. But Powell assured lawmakers that post-pandemic price hikes will not be “particularly large nor persistent” and that the Fed has the tools to bring inflation to heel, if necessary. But, Powell warned that greater risks exist beyond inflation. 

At the FOMC meeting in January, participants noted concerns about ongoing volatility in the corporate bond market as a significant risk. Bonds from investment-grade companies have lost more than five percent this year (counting price changes and interest payments), marking the second-worst start on record. Demand for these corporate bonds is eroding amid historically narrow spreads, inflation concerns, and improving economic conditions. The commercial real estate market, which is still struggling to recover from the pandemic, was another area of concern mentioned at the FOMC meeting. 

With these risks in mind and unemployment still elevated, Powell and Yellen both declared that the recovery is far from complete. At the FOMC meeting last week, the Fed interest rates will be kept low, though Dallas Fed President Kaplan hinted that rates could rise as early as 2022. The Fed made no attempts to adjust its large-scale asset purchases (quantitative easing), despite bond market turmoil. These purchases increased the central bank’s balance sheet from less than $4 trillion in 2019 to $7 trillion today.

The Fed’s Emergency Lending Facilities

In Powell’s testimonies this week, he reported to Congress on the now-closed CARES Act facilities created back in March of 2020. The CARES Act provided $454 billion in funds to backstop a series of facilities. These facilities, which are authorized by Section 13(3) of the Federal Reserve Act, represent some of the most significant actions the Fed took under its emergency lending powers to address the economic crisis. While several facilities successfully calmed markets, the efficacy of other 13(3) facilities such as the Main Street Lending Program and the Municipal Liquidity Facility was mediocre at best, lending out only a fraction of their allocated funds. 

In November, five of these lending programs were allowed to expire at the end of 2020 by then-Treasury Secretary Mnuchin. Mnuchin’s decision was controversial. Democrats argued that doing so violated Congressional intent and amounted to a political effort to hamstring the incoming administration. December’s stimulus bill settled the issue, returning the remaining $429 billion in unused funds back to the Treasury and out of reach of the Biden Administration. The Special Inspector General for Pandemic Response has opened an inquiry into whether politics played a role in Mnuchin’s decision to shut down the facilities.

Odds and Ends

The FOMC’s updated projections for 2021 are not the only exciting development in financial policy these past few weeks. Other significant developments and hearing discussions include: 

  • Changes to the Supplementary Leverage Ratio (SLR): Last week, the Federal Reserve announced the expiration of its COVID-era emergency measure to the SLR, prompting a dip for bank stocks. But the Fed hinted at the possibility of re-evaluating “the current design and calibration of the SLR over time,” in order to avoid “constrain[ing] economic growth.” During the pandemic, banks were allowed to exclude their central bank holdings of Treasury securities from SLR reporting, effectively lowering their capital requirements. The temporary change, instituted in May, was an effort to boost bank lending. While industry lobbyists fought hard to keep the rule change on the books, Powell soundly decided to dial back the SLR rule. Defying big banks by letting the SLR rule expire underscores Powell’s moderate tendencies, as did his forceful advocacy of additional fiscal relief in the face of Republican thumb-twiddling over the summer.
  • SIFI Designation of Asset Managers: At today’s Senate Banking hearing, Sen. Warren interrogated Yellen on whether asset managers like BlackRock should be designated as systemically important financial institutions (SIFI). SIFI designation by the Financial Stability Oversight Council (FSOC) enables regulatory management of systemic risk of too-big-to-fail banks and nonbanks. No asset management firm has been designated a SIFI since FSOC’s formation in 2010. BlackRock is one of the world’s largest asset managers, overseeing about $9 trillion in assets. Pointing to past findings from FSOC investigations, Yellen said she thinks designation of a particular company is less important than scrutinizing the actions they take but conceded that FSOC will continue to monitor BlackRock. 
  • London Inter-Bank Offered Rate (LIBOR) Transition: Though not related to pandemic relief, Rep. Sherman asked Yellen and Powell during Tuesday’s HFSC hearing if legislation would be needed to address the transition away from LIBOR to the new Secured Overnight Financing Rate (SOFR). LIBOR, the benchmark interest rate at which global banks lend to one another, will be entirely phased out by June 30, 2023, and replaced with SOFR. The Fed will no longer publish certain LIBOR rates in 2022, but only a handful of banks have begun using the SOFR. Nearly $2 trillion of debt is pegged to dollar LIBOR and much of it cannot be easily shifted to an alternative benchmark. Yellen encouraged Congress to pass legislation addressing the LIBOR transition this year. 

More Help on the Way

With the ARP passed, another stimulus package is already on the horizon. The Recovery Act, a giant infrastructure plan, is expected to weigh in at $3 trillion. Between the two packages, that brings the running total up to $5 trillion in stimulus for 2021, causing investors and lawmakers to express some inflation concerns. 

But during the hearing, Powell swatted down these concerns, saying that any inflation will neither be significant or persistent. Powell, without commenting on pending legislation, seemed sure that another $3 trillion in stimulus would not hurt the economy but is necessary to build the economy back better. And the same applies to the paradox of urging additional support while forecasting robust growth — those robust projections for this year are dead-cat bounce statistics that look better than they are and, more important, may be temporary without additional support.  

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