Wednesday's Market Minute: Now Is Powell's Chance To Be Volcker

This is Jerome Powell's chance for the legacy of Paul Volcker. The Fed chair has told us so many times how serious he is about taming inflation, and that he finds inspiration from the Fed chair of the '80s who weathered multiple bank crises on the way to that goal.

The collapse of three tech-centered banks has investors on edge and the fallout remains uncertain. But the government has already taken extreme measures to backstop the economy, support depositors, and tourniquet the bleeding in such a way that systemic shock is unlikely. Financial conditions have tightened as a result, which does alleviate the Fed from raising by the 50 basis points that were otherwise appropriate, but we are still far enough from a crisis for the central bank to retain its credibility as an inflation-fighter in the near term.

The conversation may be different if we weren't in the midst of a 5-month rally in stocks, but the reality is the sharp pivot to risk-on by investors since October was its own force in loosening financial conditions to the most accommodative in a year. The structural failures that we're seeing now are the result of poor risk management and levered speculation that should be viewed as a natural part of the cleansing that higher interest rates have had on everything from tech companies to consumer stocks, and myriad businesses that have proven too weak to survive a non-zero interest rate regime. It's a sector-agnostic process that includes financials.

Higher interest rates were merely the spark that started the fire at these banks whose client base was an effective tinder box of concentrated exposure to unprofitable tech, crypto, and venture capital assets that are natural collateral damage in the downswings of economic cycles. The problems at Silvergate, Signature and Silicon Valley Bank are far more idiosyncratic than the insidious plague of inflation that threatens to stay with us for generations if we do not act.

Powell's biggest mistake to-date has been underestimating the connection between loose financial conditions, inflation, and the structural problems that arise when market participants are starved for yield. The bodies of this mini-crisis aren't even cold yet and investors are already pouring back into the low-quality assets that were at the core of the meltdown. It doesn't matter how bad inflation still is -- they think Powell will chicken out at the first sign of pain. If he does, we should never take him seriously again.

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