Will Jerome Powell Play a Role in the Debt Crisis?

WOULD FED CHAIRMAN JEROME POWELL stay on the sidelines this summer if there’s a looming default crisis that could taint U.S. debt? The betting in this town is that Powell eventually may have to get involved.

POWELL’S SPEECH LAST WEEK IN SWEDEN now looks, in retrospect, as a warning from the Fed Chairman that he doesn’t want to get involved in any political issue, including the debt ceiling controversy. He has stated that a Fed bailout is a “loathsome” option.

BUT WHAT IF A DEFAULT LOOKS LIKELY this summer? Would Powell refuse to budge if global markets are in disarray because of a U.S. debt crisis? We think he would have to take action.

HIS MOST LIKELY OPTION would be to jawbone, warning of dire consequences if Congress doesn’t act. If there’s still no deal, Powell would have to consider Fed purchases of Treasury debt that is close to default.

THERE ARE PLENTY OF OPTIONS FOR A LAST-MINUTE REPRIEVE, ranging from the far-fetched (Treasury minting a $1 trillion coin) to the more practical option of a deal between most Democrats and enough Republicans to get the debt ceiling raised. Any capitulation by Republicans probably would cost Kevin McCarthy his job, as dissident House hard-liners reject any deal that doesn’t impose huge spending cuts.

POWELL MUST REALIZE that any sign that he might act to avoid a default would, ironically, be a disincentive to for Congress to cut a deal, since lawmakers would assume that he would act if a default was imminent. And Powell must know that if he takes action to avoid a default, hard-liners in the House would accuse the Fed of complicity in the huge spending binge.

BOTTOM LINE: We think in the next few weeks, Powell will continue to refrain from
getting involved in this fight, while warning that this has to be resolved. But if the threat becomes more imminent, Powell would be faced with a huge threat — U.S. and global markets could lose faith in Treasury debt. Who wants Treasuries if they could default?

WE CONTINUE TO BELIEVE there’s a 60-40 chance that there will be a political deal that avoids default, but that would require deep spending cuts that Republicans will have to detail soon. Both parties seem hopelessly divided, so this crisis could get worse in coming weeks.

THERE WILL BE NUMEROUS assertions from Powell and other Fed officials that they will not get involved in the talks, which seems likely into early summer. But this may boil down to one simple issue: Will the Fed allow the U.S. to default on its debt? At the very last minute, the Fed may have to consider Powell’s “loathsome” option.

Related: A New Push To Tax the Rich; Top Regulator Wants to Break up the Banks

The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.

The views expressed in this blog are provided as a general source of information based on information available as of the date of publication and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Speculation or stated believes about future events, such as market or economic conditions, company or security performance, or other projections represent the beliefs of the author and do not necessarily represent the view of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and AGF accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Any financial projections are based on the opinions of the author and should not be considered as a forecast. The forward looking statements and opinions may be affected by changing economic circumstances and are subject to a number of uncertainties that may cause actual results to differ materially from those contemplated in the forward looking statements. The information contained in this commentary is designed to provide you with general information related to the political and economic environment in the United States. It is not intended to be comprehensive investment advice applicable to the circumstances of the individual.

AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFA and AGFUS are registered advisors in the U.S. AGFI is a registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.