Pressure is on for Powell and the Federal Reserve to handle the exit from super-easy policies

For the Federal Reserve, implementing the simplest monetary policy in the institution’s history was difficult enough. Going out won’t be a treat either.

This is what the central bank faces on its way.

On Friday, investors will learn more about what Fed Chairman Jerome Powell thinks about the economy. They also expect to get at least some more clues as to how it will guide the central bank’s exit from the measures it has taken to save the country’s economy from the Covid-19 pandemic. He will be speaking at the Fed’s annual Jackson Hole conference, which will be held virtually again this year.

The first on the role of the Fed is to withdraw money by printing the roughly $ 120 billion in bonds it buys each month to stimulate demand and lower long-term interest rates.

After that, the road becomes more difficult.

At some point, the Fed will look to raise short-term interest rates from the near zero anchor point where they have been since March 2020. The return to normal rates did not end well for the Fed the last time she tried to do so. therefore from 2015-18, because it had to stop mid-cycle in a context of economic slowdown.

Therefore, the markets could be excused for being at least a little nervous this time around. The Fed not only needs to reverse its most aggressive easing policies ever, it needs to do so with precision and hopes not to break anything in the process.

“Every change in the Fed’s monetary policy is important,” said Priya Misra, global head of rate strategy at TD Securities. “But I think it’s especially significant today because we know growth is slowing and the Fed is trying to pull out.”

Indeed, the economy is still well in a strong recovery from the depths of the pandemic, which resulted in the steepest but shortest recession in U.S. history. But the rebound seemed to at least stall. The Citi Economic Surprise Index, which measures actual data against Wall Street estimates, hit an all-time high in mid-July. But the index has now fallen to levels last seen in June 2020.

Fed officials themselves expect significantly slower growth in the coming years at a time when monetary and fiscal policies will be tighter. This raises more questions about whether Powell and his cohorts can get the right exit.

“Are they coming out in the right place? Are they coming out at the right time, at the right scale? Given the downturn in the economy, we have questions on both, ”Misra said. “The market is pricing a policy error.”

What Misra means by policy error is that the current pricing of federal funds futures in the market that trades around Fed rate moves indicates that the Fed’s central bank will not be able to raise its rate. that a few times up to maybe 1.25%. Then it will have to stop because the growth stalls.

Such low rates frighten Fed officials as they leave them little leeway to ease policy in times of crisis. This was roughly where the funds rate was at the start of the pandemic crisis, down substantially from the 2.25% to 2.5% target range where the Fed ended its last round of hikes. rates in December 2018.

The calculation of how to manage all of this will be up to Powell from a communications standpoint and the rest of the Federal Open Market Committee in terms of the actual mechanics.

“The tapering is important because it is a very good measure of not only the credibility of the Fed, but in terms of communication, the quality of the strategy and its transparency,” said Deepak Puri, director of investments for Americas at Deutsche Bank Wealth. Management. “In 2013, the Fed made mistakes in the way it communicated on tapering.”

This 2013 episode, called Taper Tantrum, as it’s known now, is the only model the market has on how the Fed might proceed.

TD Securities Misra pointed out that the Fed was already showing that it had learned a lesson from the previous episode by facilitating the crumbling of the market. The 2013 proclamation by then Fed Chairman Ben Bernanke was seen as blunt, and it pushed interest rates and stocks down for several months.

The Covid-19 casts doubt on the direction of growth. Corn several regional Fed chairmen who spoke to CNBC this week said the virus appears to have little impact on growth and so far is not weighing on their economic forecasts.