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Powell channels his inner inflation hawk, but Omicron may have other plans

·Editor focused on markets and the economy
·3 min read
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This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Wednesday, December 1, 2021

A suddenly hawkish Fed chief may find his wings clipped by Omicron

If you closed your eyes during Federal Reserve Chairman Jerome Powell’s testimony on Tuesday, you could almost hear Paul Volcker talking.

The comparison to the ex-Fed chief, who burnished his inflation-fighting bonafides by hiking rates aggressively, might be a bit of self-indulgent hyperbole (Former Fed Chair Alan Greenspan was also an inflation hawk, but frequently inveighed against wage hikes as a contributing factor behind price pressures). 

Nevertheless, Powell surprised Wall Street — and unsettled a market already addled by the rise of the Omicron variant of COVID-19 — by embracing his inner inflation fighter. By warning that the Fed could curtail its stimulus at a faster pace — and dramatically "retiring" the dreaded “transitory” word to describe inflation — Powell hewed a line that betrayed the central bank’s growing concerns about skyrocketing prices. 

While most of Wall Street expects the first rate hike in over two years will happen by June, the Fed chair’s comments suggest the central bank may surprise by pulling the trigger earlier, at least in theory.

Even bonds, benefiting from safe-haven buying that's driving down yields, have been signaling a tempering of Fed expectations, with the chairman’s acknowledgement of inflation catching market observers off guard.

“Given the consistency of the message about tapering coming from the Fed in recent weeks, it now looks like it will take a deterioration in the public health situation over the next two weeks to prevent the FOMC from deciding to quicken the pace of tapering at the next meeting,” JPMorgan Chase economist Michael Feroli wrote Tuesday, 

He noted that Powell’s question and answer remarks were “a fair bit more hawkish” than the prepared testimony released the day prior. Indeed, Powell did give a nod to the risks posed by Omicron, which has made investors jumpier than usual in the wake of Friday’s stunning sell-off

But with the world watching the major stock benchmarks, the real action appears to be happening in Treasury markets (a topic the Morning Brief has mentioned before), which is slowly walking back from the inflation premium baked into surging yields.

According to Tradeweb data, interest rates on 10-year (^TNF) and 30-year Treasuries (^TNX) have dropped precipitously from last week’s highs, and are on track for a monthly drop. Surprisingly, the 5-year yield soared to the highest close since February 2020 last week — but also wrapped up the month lower than October's close.

Currently, bonds “are caught between two very powerful forces,” RegentAtlantic co-head of investments Andy Kapyrin told Yahoo Finance Live on Tuesday. “The path of least resistance for rates is higher. In the face of volatility, Treasuries will always have a bid though.”

And let’s not get started on oil prices (CL=F), which are now dangling near bear market territory below $67, after a run to near $85 per barrel earlier this fall. According to Brad McMillan, chief investment officer for Commonwealth Financial Network, the latest COVID mutation “could have unexpected effects that support the economy and the markets. Energy prices are down, which should help pull inflation down.”

He added: “With lower inflation likely and with worries about the recovery, the Fed may pause in tightening monetary policy, which seems to be showing up in markets as interest rates have pulled back in recent days. Easier policy and lower rates will likely act to support markets, which will offset any economic damage Omicron does.”

All of that suggests Powell’s newfound hawk could easily run headlong into the black swan that Omicron poses. Stay tuned.

By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek

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