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Overview: Fed Governor Powell weighs in on monetary policy

Phalguni Soni

Overview: Will the Fed's doves and hawks find common ground? (Part 8 of 11)

(Continued from Part 7)

Jerome Powell

Jerome Powell has been on the Board of Governors since May, 2012, to fill in for an unexpired term which expired on January 31, 2014. He has since been re-appointed for a full 14-year second term on June 16, 2014. Mr. Powell is a former partner at the Carlyle Group and former Assistant Secretary and Undersecretary of the Treasury responsible for policy on financial institutions. He is widely regarded as a centrist.

In recent remarks made on June 6, 2014, at the Institute of International Finance in London, UK, Mr. Powell addressed several key issues at the crux of the Fed’s monetary policy.

Mr. Powell’s take on forward guidance

“My view is that forward guidance has generally been effective in providing support for the economy at a time when the federal funds rate has been pinned at its effective lower bound.” According to Mr. Powell, forward guidance about the likely path of interest rates has had three major impacts:

  1. It’s lowered term premiums for longer-term investments.
  2. Market expectations have kept rates low for medium- and long-term debt.
  3. Forward guidance “has reduced the likelihood that rate expectations will subsequently shift upward in ways that the Committee doesn’t intend. Event studies as well as market-implied quotes and surveys corroborate the view that guidance has reduced medium- and longer-term interest rates and has held down volatility as well.”

Volatility, as measured by the VIX, or the index commonly known as the “fear factor,” reached its lowest point in over seven years on June 18—the day the Fed’s June Federal Open Market Committee (or FOMC) concluded and press statement was released.

On the likely path and lift-off in the Fed funds rate

Mr. Powell remarked that the timing of the lift-off in the Fed funds rate would depend on economic conditions. He also believes that the Fed may not increase rates immediately after its inflation and employment targets are met due to “the lingering effects of the financial crisis, including lower potential growth for a time.”

Impact of market expectations on bond yields

Market expectations have played a key role in determining the yields on Treasury securities, both long-term (TLT) and short-term (BSV). Although there’s been no increase in the base rate, Treasury yields increased in 2013 ever since the Fed’s April 30 FOMC meeting, when the Fed first hinted at the taper. While the yields on the benchmark ten-year Treasuries (IEF) increased by 84 basis points over the period April 30, 2013–June 27, 2014, five-year Treasuries (IEI) increased by 96 basis points over the same period. Yields on investment-grade corporate bonds (LQD), as represented by the BofA Merrill Lynch U.S. Corporate Master Effective Yield Index, increased by 28 basis points over the same period.

In the next three sections, we’ll discuss the new additions to the Board of Governors and the FOMC and how their views impact financial markets.

Continue to Part 9

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