Mizuho daily insights by Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Powell’s Soothing Balm …
Jerome Powell may as well be wearing a shining armour and riding a white stallion … to the the rescue of markets fretting about the sharp upswing in bond yields; as the Fed Chair assuaged inflation concerns, and affirmed commitment to policy accommodation. His assertion to the Senate that policy accommodation not only remains appropriate but is warranted; substantiated by his view that the ” economy is a long way from … employment and inflation goals”, requiring “some time for substantial further progress”.
Furthermore, he impressed upon the Senate that ($120bn/mth) QE will be maintained at the current pace “until substantial furtrher progress has been made”. And this is in the context of expectations cost-push inflationary pressures in the interim are likely to be temporary. In short, Powell’s assurances of policy support being maintained, rather than demurring to concerns of pipeline inflation risks, provided some relief for markets. Dow and S&P500 reversed significant early losses to finish in mild positive territory (0.1%) while despite Nasdaq 0.5% lower, it recouped substantial ground, sparing much deeper losses.
FX-wise, Powell’s soothing words appear to provide modest USD backstop (EUR sub-1.22 stall; AUD bulls slowing above 0.79, USD/SGD decline dampened at sub-1.32 and sub-105 USD/JPY averted); partly reflecting confidence in policy and perhaps pick-up in real yields. But while 10Y UST bond yields eased back a touch below 1.35% (after 1.4% test) this was arguably not a dramatic U-turn; with 5Y-30Y curve steepening. Powell’s diminished impact on yields, particularly in dissuading reflation boost to long-end yields is partly self-inflicted insofar. Specifically, Powell’s response that sharp run-up in yields are “a statement of confidence” imply Fed’s tolerance for, if not comfort with, rising yields. The nagging feeling is that this has potential to come back and haunt …& Thoughts on Policy Bond-Aid.
Big picture being, that Powell’s ability to soothe with clarity on policy stimulus stability is a welcome relief but not a resolution to tension, if not conflict, between reflation bets driving up costs and desired market conditions to steer through uneven economic recovery. Point being, some policy band-aid, or forgive the pun, bond-aid may be required to ensure that optimism-driven yield surge doesn’t get so far ahead that it hobles the recovery. Tellingly, the ECB appears to be somewhat more concerned, having suggested just a day earlier that it is “closely monitoring the evolution of longer term nominal bond yield”. Question is, what can the Fed, or any other central bank confronted with premature and overdone yield upswings, resort to? Three options, while not exhaustive, present themselves. One is a rather crude firepower signal of just opening the QE tap wider to purchase more bonds, thereby lowering yields. But this comes with all the attendant asset price distortions.
Another, a more nuanced QE tweak, reviving “Operation Twist” type of tool to influence term structure, and specifically anchor long-end yields. But this requires a large enough holding of shorter-end securities to “swap”, and may have unintended money market disruption. Finally, the Fed could “short-circuit” by adopting BoJ-type YCC (yield curve control that targets specific levels of long-end yields). But this creates confusion and constraints between, quantity (QE) and price (YCC) targets of QE; and may be even trickier to unwind without an epic “tantrum”. All options entail cost. None are lasting solution; just temporary fixes to buy time for self-healing.
Source: Mizuho Bank Ltd