Fed under Powell more hawkish, while easier on regulation

A Jerome Powell Federal Reserve is expected to balance tighter monetary policy with easier regulation, according to Peter Chatwell, head of rates strategy at Mizuho International.

Jerome Powell will be sworn in as chairman of the US Federal Reserve (Fed) on 5 February 2018. He is seen as the continuity candidate. But what is he inheriting from outgoing Fed chair Janet Yellen, and how will he manage market expectations?

Powell's inheritance

Three, possibly four, quarter point US interest rate increases are expected in 2018, according to Peter Chatwell, head of rates strategy at Mizuhi International. The stronger oil price and weaker US dollar could be a 'perfect storm' to trigger higher inflation in three to six months.

Hawkish Powell and a tighter monetary policy

Powell will not be the only new face at the Fed. The US central bank will soon have a new vice chair and New York Fed president. The change in the top three Fed roles will lead to an easing up on the regulatory side, allowing banks to be more aggressive in lending to the real economy, Chatwell thinks. This will allow monetary policy to be tighter.

Given Powell's background in banking, rather than economics, his likely bias towards deregulation comes as no surprise to many analysts. The past decade in the aftermath of the global financial crisis has been characterised by a major ramp up in financial sector regulation to avoid a repeat of the mistakes in the run-up to 2007.

Unwind of the great rotation?

Once the Fed's balance sheet reduction reaches full tilt in October, an unwinding of the so-called ‘great rotation’ is likely, Chatwell says, with investors selling out of riskier assets and coming back into lower risk assets.

The great rotation is the idea that money will flow out of stocks and into bonds, as bond yields increase enough to lure money away from equities.

Chatwell points out that the Fed Funds rate will at some point be above the S&P 500 dividend yield of 2%, which he says is a trade opportunity, but he says it does not herald a bear market for bonds. He expects a flatter bond yield curve, with the riskier end of the curve coming down in price.

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