Federal Reserve Chairman Jerome Powell dismissed concerns of inflation, indicating that the central bank would stay the course as bond yields creep up.
Powell told the House Financial Services Committee on Tuesday that the dollar was “perfectly reliable and stable in value” and emphasized that the central bank’s actions were “providing accommodative financial conditions and supporting the economy” out of the pandemic-induced recession.
After the coronavirus pandemic caused one of the worst market slides in modern history, investors flocked to safe-haven assets like Treasury bonds, causing yields to plummet to all-time lows — the 10-year Treasury yield bottomed out at just 0.318% in March.
‘STATEMENT OF CONFIDENCE’: POWELL SAYS BOND MARKETS VALIDATE FED STANCE AMID INFLATION FEARS
But after trillions of dollars in federal relief, accommodation from the Federal Reserve, and a number of reports projecting one of the strongest periods of economic expansion in decades, investor optimism has led to a valuation boom — stock indices and Bitcoin and other cryptocurrencies are at or near all-time highs, and now Treasury yields have risen, leaving some worried about runaway inflation.
Economists are skeptical that the rise in bond yields will translate to violent inflation. Don Ellenberger, a senior portfolio manager at Federated Hermes, told the Washington Examiner that the recent rise in bond yields was a sign of a return to pre-pandemic economic activity, not inflation.
“If you think the economy this year will get back to where it was prior to COVID — and if you look at most projections for GDP, that will happen this year — then you should ask yourself: Why shouldn’t rates be where they were before COVID struck in the first quarter of last year?” Ellenberger said.
Before the March 2020 crash, the 10-year Treasury yield was just below 2%. It’s now at 1.37%.
“People buy Treasury bonds as a hedge against something bad happening. They tend to be something that people want to hold during risk-off periods like we had last year,” Ellenberger continued. “The market is much more confident now that the market is recovering. That flight to quality bid is being unwound here.”
Carl Weinberg, chief economist at High Frequency Traders, told CNBC that inflation expectations based on bond yields have experienced an “unanchoring” from reality.
“An important element in inflation are wages and people getting higher wages during a time of still very high unemployment and still a lot of slack in the economy,” Weinberger said. “But we see no indication of that whatsoever. What we see is the perception of inflation being fueled by energy prices.”
Economists agree that inflation will rise in the coming years — likely beyond the Fed’s 2% in the short term. But that’s in part because the Federal Reserve is actively pursuing higher inflation after decades of falling below the target.
“Last year, the Fed moved to something called the average inflation targeting policy,” Ellenberger said. “For the last 30 years, the Fed worked hard to put a cap on inflation. Now, they’re telling us they’re going to try and put a floor under inflation. The Fed actively wants inflation to go higher … The Fed wants inflation to go up, and the way they’re going to achieve that is to let the economy run hot.”
Ellenberger cautioned, however, that with trillions of dollars so far in recovery packages and an upcoming infrastructure package, the rapidly expanding federal deficit could lead to levels of inflation beyond the Federal Reserve’s expectations.
“The checks that everybody got last year, that they’re getting this year, the infrastructure, that’s not being paid for with tax money — that’s being paid for by money that’s being printed by the Fed,” Ellenberger said. “We are now effectively monetizing the debt. This is the age of Modern Monetary Theory, this is the age of higher and higher deficits, this is the age of debt monetization. It is here, it has started. And what ends it is when inflation starts to get too high. And that will happen.”
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Powell fielded similar concerns from Republicans on the House Financial Services Committee. After Ohio Rep. Warren Davidson cautioned against the “printing of more U.S. dollars” to finance future recovery packages, Powell said: “That’s not at all what’s happening.”
“We could sell all of our debt. We issue United States obligations in the form of reserves when we buy Treasuries,” he said. “We’re not actually changing the amount of obligations outstanding on the part of the Treasury. We’re substituting an overnight reserve for a Treasury bill. It has no effect on the overall outstanding obligations of the United States when we do that.”
