Markets Turn Away from Powell... 'Tolerating Inflation' Instead Fuels Anxiety

US Treasury Yield Rises 1.75% Intraday
Market "Fed Underestimates Inflation Risk"
Fed Likely to Consider Extending SLR Exemption

Jerome Powell, Chair of the U.S. Federal Reserve (Fed)
[Photo by Reuters Yonhap News]

[Asia Economy New York=Correspondents Baek Jong-min and Kim Su-hwan] The effect of Federal Reserve (Fed) Chairman Jerome Powell's remarks on tolerating inflation and maintaining zero interest rates to soothe the market's inflation concerns ended after just one day. Interest rates soared and the stock market fell just one day after reaffirming that there would be no rate hikes until 2023. This has led to observations that Powell's 'dovish' policy has ironically worsened the market's inflation concerns, creating a dilemma.

Is Powell Fueling Inflation?

On the 18th (local time), the yield on the U.S. 10-year Treasury note rose intraday to 1.75%, the highest level since January 24 of last year. According to the Bloomberg Barclays index, long-term Treasury prices of 10 years or more have fallen 14% so far this year. If this continues until the end of this month, it is expected to mark the worst quarterly decline in Treasury prices since the 1980s. Amid this rise in bond yields, major U.S. indices also turned downward. The Dow Jones Industrial Average, which had surpassed 33,000 for the first time the day before, fell 0.46%, and the S&P 500 index dropped 1.48%.

Earlier, Powell sent a bold signal to calm market inflation fears by stating at a press conference following the recently concluded FOMC meeting that the Fed would tolerate inflation somewhat above its self-set 2% target, but this did not seem to take effect.

Contrary to Powell's intentions, the market moved because there are concerns that his tolerance of inflation could further fuel price increases. Tolerating inflation means prices will continue to rise, which could ultimately accelerate the timing of interest rate hikes.

The Wall Street Journal (WSJ) reported, "There are market concerns that unprecedented postwar stimulus measures ($1.9 trillion) and the rapid economic recovery after COVID-19 will stimulate inflation," adding, "Investors believe the Fed is underestimating inflation risks." Frank Levinsky, chief strategist at Aegon Asset Management, analyzed, "Economic uncertainty has increased to the point where predicting the inflation cycle is difficult."

The possibility of inflation leads to a sell-off in U.S. Treasuries, causing bond prices to fall (and yields to rise). Matthew Miskin, chief strategist at John Hancock Investment Management, said, "The Fed's tolerance of inflation will inevitably cause a sharp rise in long-term Treasury yields."

Additionally, there is analysis that the Bank of Japan's expansion of the allowable fluctuation range for 10-year government bond yields also had an impact. According to the Nihon Keizai Shimbun on the 18th, the Bank of Japan plans to widen the yield fluctuation band from ±0.2% to ±0.25%.

This policy change creates room for Japanese government bond yields to rise further, which is interpreted as likely to weaken U.S. Treasuries. MarketWatch reported, "As demand for Japanese government bonds increases, the likelihood of increased selling of U.S. Treasuries has grown."

What Cards Does Chairman Powell Have Left?

To overcome this dilemma, an extension of the supplementary leverage ratio (SLR) exemption for large banks is emerging as a possible card the Fed can play. The SLR is a system requiring banks to hold a certain level of capital before purchasing additional government bonds. Exempting this can drive demand for government bonds and is expected to help suppress rising yields. WSJ reported, "Uncertainty over whether the exemption, which expires at the end of this month, will be extended has increased market anxiety, leading to continued selling of government bonds."

In addition, the Fed could employ the so-called 'Operation Twist,' which involves selling large amounts of short-term Treasuries and buying an equivalent amount of long-term Treasuries.

On the other hand, there are views that the effect Powell intends will soon take full effect. Famous U.S. investment expert Jim Cramer said on CNBC that day, "The winner of the war between the Fed and bond investors will ultimately be Powell," adding, "Powell's inflation outlook is the most accurate."

This content was produced with the assistance of AI translation services.