Interpretation of Powell's speech

Discussing Powell's speech last night: Approaching the end of quantitative tightening. Key points:

1. The Federal Reserve's balance sheet was the focus of this speech. Powell began by extensively explaining the background of the Fed's balance sheet and its critical role in monetary policy. Powell explicitly stated: The Fed may stop quantitative tightening (QT) in the coming months. QT has been the Fed's policy since 2022, aiming to withdraw the trillions of dollars in liquidity released during the pandemic to stimulate the economy. From last year to now, the Fed has slowed the pace of QT multiple times, from initially reducing $65 billion in Treasury securities and $35 billion in mortgage-backed securities (MBS) monthly to now reducing $5 billion in Treasuries and $35 billion in MBS. Of course, Powell did not specify an exact timeline—it could be within the next quarter or the next six months. QT drains liquidity from the market, and stopping QT means no further draining. While it’s still far from quantitative easing (QE), if the Fed does halt QT at a future FOMC meeting, it would effectively mean an increase in market liquidity.

2. Why is Powell talking about stopping QT now? On one hand, the Fed's balance sheet reduction has already reached the previously set target range of $6–6.5 trillion. On the other hand, Powell emphasized last night the importance of maintaining liquidity in the overnight funding market. He noted, "Some signs indicate that liquidity conditions are gradually tightening, including a general rise in repo rates and more pronounced but temporary market stress on certain dates." The Fed's long-term plan is to stop QT when bank reserves are slightly above ample levels, and this point may arrive in the coming months. The core concern is to avoid the "taper tantrum" market volatility that could arise in the late stages of QT. The cash crunch in September 2019 was caused this way—the repo crisis was a market shock amid tight liquidity, with the main culprits being scarce excess reserves, combined with tax payment deadlines, heavy Treasury issuance, and large banks being forced to hold significant reserves due to intraday liquidity regulations.

3. Regarding economic data, employment, and inflation trends: 1) Powell pointed out that although the government shutdown has led to missing some economic data, available information shows that employment and inflation trends remain similar to before, with economic growth slightly stronger than expected. However, the labor market shows signs of weakness, such as slowing hiring, fewer job openings, and low but potentially rising unemployment. He admitted, "The downside risks to employment have increased." The evidence Powell cited includes not only the Fed's internal statistics but also private data like ADP. Powell also said the Fed is monitoring a range of non-government data to navigate this shutdown period. 2) On inflation, he noted that the 12-month core PCE inflation rate in August was 2.9%, slightly higher than earlier this year, as rising core goods inflation outpaced the continued decline in housing services inflation. Current data and surveys suggest that rising goods prices mainly reflect tariffs rather than broader inflationary pressures. Consistent with these effects, short-term inflation expectations have risen this year, while most long-term inflation expectations remain aligned with the 2% target.

4. How to interpret Powell's speech: 1) Personally, I’m more interested in his stance on inflation and employment. His exact words were: "There is indeed no risk-free path now, as (inflation) appears to be continuing to rise slowly... and the labor market is already showing significant downside risks. Both supply and demand for labor have dropped sharply." Clearly, as long as inflation doesn’t rise faster than expected, Powell is more concerned about labor market risks. A rate cut in October is highly likely. 2) Of course, the current issue is the ongoing government shutdown. If official data isn’t available by the end-of-month FOMC meeting, the Fed will likely rely on previous data. Yesterday, Powell still prioritized labor market risks—frankly, I think he might already have the September nonfarm payroll report. 3) Overall, Powell’s speech showcased the Fed’s dual-track strategy on interest rates and balance sheet operations, addressing both economic realities and market expectations. In the coming months, the pace of rate cuts and QT cessation will be the market’s focus. During liquidity stress, the Fed may lean dovish. This time, Powell also unusually signaled a clear direction—possibly pausing QT, which is a positive signal for the market. (Reposted from X)