The Federal Reserve needs to deliver a Volcker-style shock to drive down asset prices if it wants to slow inflation without causing a recession, according to Credit Suisse Group AG strategist Zoltan Pozsar.
Policy makers should stoke volatility to set off corrections in assets including stocks, houses and Bitcoin, deterring early retirement and driving people into the workforce, Pozsar wrote in a note to clients. His comments harked back to the way Paul Volcker broke the back of inflation in the 1980s with massive rate increases.
The difference this time is policy makers need to bring “about more supply of labor, not less demand for it,” and slow inflation in services which is driven up mainly by higher housing costs and the availability of workers, Pozsar said. The key to turning those drivers around is to tighten financial conditions by increasing longer-term borrowing costs that underpin asset valuations, the influential analyst said.
“Maybe the Fed should hike 50 basis points in March, put an end to press conferences, and sell $50 billion of 10-year notes the next day,” Pozsar wrote.
It’s a view that shines the spotlight on the windfall that years of quantitative easing has had for capital owners, a policy that critics say has inflated asset prices and contributed to rising inequality. Since the wake of the global financial crisis, the Fed’s balance sheet has grown four-and-a-half-fold to almost $9 trillion.
Policy Headwinds
Fed Chairman Jerome Powell has pledged to bring under control the strongest inflation in four decades. Yet the pace of rate increases required, according to market pricing, would make a severe slowdown in the economy all too likely.
Complicating the picture further is that goods prices have turned into a sustained source of price pressures, Pozsar said. Meanwhile, the Fed’s updated dual mandate calls for it to avoid creating recessions and yet it can only rein in goods costs through rapid interest-rate hikes that will curb demand.
Despite the aggressive positioning in the market -- bond traders are now pricing in just over six 25-basis-point hikes this year -- long-term borrowing costs have not moved up enough. In particular, mortgage rates need to get noticeably higher, Pozsar said.
The average 30-year U.S. mortgage rate climbed almost 1 percentage point this year to 4.23%, according to Bankrate.com, which is still about half a point below its peak in 2018.
Redistribution
In the minutes of the Jan. 25-26 Federal Open Market Committee meeting, released Wednesday, a few participants noted that asset valuations were “elevated across a range of markets” and raised concern that a major realignment of asset prices could contribute to a future downturn.
The U.S. central bank is currently set to phase out its asset-purchase program in mid-2022 under a plan announced at the start of November to slow buying by $15 billion a month.
Signs are growing that market is also getting nervous. The yield curve --- a broad measure the expected trajectory of borrowing costs -- has narrowed to levels levels last seen since the pandemic first hit, with rates traders wagering the Fed will have to cut rates again in 2024.
Yet Pozsar maintains that the Fed can steepen the slope by driving up term premia instead -- the technical term for the extra yield investors demand to hold longer-date notes -- without killing growth.
“The decisions of central bankers are always redistributive,” he said. “For decades, redistribution went from labor to capital. Maybe it’s time to go the other way next.”
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