Federal Reserve Chairman Jerome “Jay” Powell stood at a podium at the Fed’s headquarters in Washington, D.C., sending a stern message to the global investment community: The central bank was going to tighten the money supply, even if it hurt.
The Fed had been maintaining rock-bottom interest rates and pumping trillions of dollars into the banking system through an extraordinary program called “quantitative easing.” But now it was time to withdraw that stimulus, to keep the economy growing and inflation low. The process, Powell proclaimed, was on “automatic pilot”: It would not be slowed or hindered, even if stock prices plunged or the bond market panicked. The Fed was created to do hard things like this, insulated from political pressure, and Powell was determined to do them. Taking a more hawkish stance “has been a good decision,” Powell said. “And I don’t see us changing that.”
It was a scene that could have played out any number of times in 2022, as Powell and the Fed stepped up to fight an unprecedented surge in consumer prices. But this speech took place on Dec. 19, 2018. Powell was still in his first year as Fed chair. The Fed had been pursuing “QE” for nearly a decade, to combat the effects of the Great Recession—and worries over how its actions could distort the economy were growing in Washington and on Wall Street alike.
So Powell assumed the role of financial disciplinarian—and the markets rebelled. Prices for stocks, bonds, and commodities fell in a frighteningly synchronized way, stunning analysts who thought such a coordinated downturn was unthinkable. Over just a three-week span, the S&P 500 fell into correction territory, dropping nearly 16%. On Christmas Eve, normally a quiet trading day, the Dow Jones industrial average fell 3%. Even President Trump, who had appointed Powell a year earlier, began hectoring him to stop tightening, accusing him on Twitter of relying on “meaningless numbers.”
Powell had known this could happen: He predicted such turmoil himself earlier in his career at the Fed, even as he advocated for an end to QE. The bank’s loose monetary policy had pumped up asset prices; reversing that policy would come with costs.
But as those costs came due, in real time, Powell and the Fed flinched. Within weeks, Powell abandoned the notion of tightening. “The case for raising rates has weakened somewhat,” he said at a press conference the following January. Markets swelled on the news, with stocks and bonds rising in tandem, just as they’d previously fallen together. Autopilot? Disengaged.
The episode became known on Wall Street as the Powell Pivot. And it signaled that Jay Powell, once seen as a contrarian at the Fed, would uphold a tradition that went back to the days of Alan Greenspan’s chairmanship in the 1980s and ’90s. If things went haywire in markets, the Fed would step in to protect investors—even if it risked making inflation and other problems worse down the road.
Understanding the Powell Pivot is key to understanding the stakes in today’s fight against the inflation that’s running at its hottest level since the early 1980s, as well as the stock and bond market volatility that has accompanied the fight. Powell has once again promised that the Federal Reserve will tighten the money supply. But many stakeholders—investors, bankers, lawmakers—are betting that he’ll pivot again.
“I think a lot of people didn’t think Powell would be serious, because he hasn’t been,” says Sen. Rick Scott (R-Fla.). Scott says he has met with Powell multiple times during the past year to figure out how aggressively Powell might tighten policy. Scott still isn’t sure. (Powell declined to be interviewed for this article.)
Similar uncertainty is playing out daily in the markets. Stock and bond prices plunge when alarming inflation data arrives, since it indicates that the Fed will continue raising rates; they rally on any sign of weaker economic activity that might persuade the central bank to back off. Stock-index moves of two percentage points in both directions on the same day aren’t unheard of. A key market volatility tracker, the CBOE Volatility Index (VIX), started to rise in late 2021 and has stayed elevated ever since. Markets and economies in Europe and Asia are quaking, too, since rising rates in the U.S. can undermine the value of their currencies.
In eras past, investors might have counted on the Federal Reserve to be an anchor of stability. The central bank is the most powerful institution in finance, and the Ph.D. economists who run it were once seen as the equivalent of brilliant engineers in the control room of a power plant, deftly working the levers to tighten the money supply when inflation was high and then loosening it again when the economy needed a boost. But those days are over—thanks to a decade of the Fed’s own unprecedented, sweeping interventions in the economy. Years of zero-percent interest rates, coupled with a radical acceleration of new money printing, have fundamentally redrawn the financial landscape. And it has transformed the Fed’s leaders from all-knowing engineers to a group of people feeling their way through a dark room.
One way to measure the change, and the scope of the Fed’s footprint in the economy, is to plot the size of the Fed’s balance sheet, which increases when the Fed creates money. Between 2008 and 2014, under QE, the balance sheet exploded from $900 billion to $4.4 trillion. That was just the beginning. When COVID hit, Jay Powell oversaw the largest economic intervention in history, roughly doubling the balance sheet to nearly $9 trillion, where it hovers today. The consequences of this policy are far-reaching. The Fed created all that money by purchasing U.S. Treasury bonds (more on that later). By the middle of this year, the central bank owned 25% of all outstanding U.S. Treasury bonds.
When an entity’s footprint is that big, every step can cause an earthquake—as the Fed has proved in 2022. Under Powell, the Fed raised rates six times between March and November, bringing the benchmark short-term rate from 0.25% to 4%, with a seventh increase likely in December. Powell has paused QE, as well. Meanwhile, stock prices have fallen. U.S. debt has gotten far more expensive. Corporate borrowers are at risk. And no one really knows how bad it might get.
Powell comes to this job from a background that makes it difficult to predict his next move. He is the first noneconomist to lead the Fed in decades. For his entire career, he has been a fixer between the worlds of big government and big money on Wall Street. Trained as a lawyer, he’s a former private equity dealmaker, having worked at the venerable Carlyle Group from 1997 to 2005—where he led one spectacularly profitable buyout, of an old-line industrial conglomerate called Rexnord. Powell is a true creature of the nation’s capital, having been born in the wealthy suburbs of Washington and worked around the rich and powerful his whole career.
Still, there’s an ordinary-guy quality to Powell. He’s quick to make a joke at his own expense, with a kind of humility that seems impossible to fake. He has been known to ride his bike to work at the Fed, to stay fit. When he talks, he unspools his comments thoughtfully, building his arguments the way a chipmaker might solder pieces onto a circuit board.
“He’s just a good thinker,” says Betsy Duke, a former Federal Reserve governor who worked closely with Powell after he joined the Fed, in 2012. Duke, like Powell, came from private-sector finance. She was always impressed with the way he thought through problems, like an investor looking at complicated data. Duke recalls when Powell gave a presentation on the cost of Medicare. He explored the very root of the problem, using data on the ratio of per-capita health care spending compared with quality of outcomes, which is much higher in the United States than elsewhere. Narrow that gap, Powell argued, and the cost problems of Medicare essentially disappear. “He makes connections that aren’t obvious from the way the data is normally read,” Duke says.
But this flexibility only heightens the mystery about Powell’s approach to inflation. He has changed positions on important monetary policy issues before, and he describes those changes as a hallmark of his leadership. These aren’t political decisions, he insists. They’re just the actions of a pragmatist responding to ever-shifting circumstances. “My views evolve with the evidence,” Powell told me in 2020.
Current and former colleagues described this as one of Powell’s strengths. On Wall Street and in Washington, however, no one is certain just which way Powell’s evolution might take him—which means they can project their hopes, or fears, onto his every utterance.
When Powell joined the Fed’s Board of Governors in 2012, he was something of a dissident. He started raising concerns almost immediately about the Fed’s core policies and its activist approach.
The Fed’s leader was Ben Bernanke, arguably the most interventionist Fed chairman in history. The central bank can’t build dams, educate students, or put a shovel in somebody’s hand. All it can do is print money, and after the global financial crisis struck, Bernanke did that to a degree unseen in history. First, Bernanke pushed the Federal Open Market Committee to keep short-term interest rates at zero. Rates had only briefly brushed the floor of zero in the past—the Fed would keep them pinned there from 2008 until the end of 2015. And it was Bernanke who launched the far-reaching and radical experiment of quantitative easing.
QE is effectively a way to pump money into bank vaults, giving those banks, in turn, more money to lend or invest to prop up the economy. To do that, the Fed contacts a big bank—say, Wells Fargo—and asks to buy $10 billion worth of Treasury bonds. When Wells Fargo sells the bonds to the Fed, the central bank simply creates new dollars to fund the purchase. Those dollars instantly appear inside the bank’s reserve account at the Fed. Over the past 15 years, the Fed repeated this transaction until it had created trillions of dollars.
Critically, all this new money was created even as the Fed was keeping short-term interest rates pegged at zero. This strategy—of pumping money into Wall Street while reducing the ability to earn interest on that money by saving it—created a powerful force known as the “search for yield.” Big investors like insurance companies or pension funds had to frantically seek higher returns from riskier investments, because rates were so low. This, in turn, drove up the price of stocks and bonds as trillions of new dollars chased the same pool of assets.
The policy dramatically increased inequality. The richest 1% of Americans own nearly 30% of the nation’s assets, up from about 18% two decades ago, according to Fed data, while the bottom half own about 5%. Since wealthier people hold a greater share of their net worth in stocks and bonds, QE helps explain the extraordinary gains at the top during the 2010s, even as most wage earners treaded water. Wall Street, meanwhile, became increasingly attuned to the Fed, and multiple “taper tantrums”—in which asset prices plunged when the Fed moved to taper off QE—helped convince many observers that catastrophe would ensue if the Fed took away the punch bowl.
Powell arrived at the Fed arguing that QE was getting out of hand: “We need to regain control of this,” he said during one market committee meeting in 2013. In another, he warned that QE had inflated some asset prices to levels that could precipitate a disaster. In his opinion, the Fed was piling up long-term risks—of runaway inflation, of a future asset-price crash—for very small short-term gains. Powell’s approach to this debate was telling. He is not the kind of guy to pound on a table or make extreme comments; rather, he builds on granular detail, overlaid with his analysis. To make his case during a debate in 2013, he shared results from a survey of 75 investment managers; 84% said the Fed was inflating the value of assets like corporate junk debt. “The eventual correction could be large and dynamic,” Powell said during another meeting, using economist jargon to describe a steep market drop.
plunge that month put pressure on the
Fed to reverse its efforts to tighten the money supply, a reversal that came to be known as the Powell Pivot.
Needless to say, Bernanke wasn’t happy to hear this. QE was Bernanke’s brainchild. It would eventually be a huge part of his legacy. And over time, Powell’s reservations eased; in 2015 he even gave a speech in which he praised QE. When asked what changed, Powell said that new data had emerged which supported quantitative easing. But Powell’s colleague and friend Richard Fisher, former president of the Fed regional bank in Dallas, told me in a 2020 interview that he was skeptical of that take. More likely, Fisher said, was that Powell conformed to the predominant views inside Fed leadership circles. “The evolution may well have come from being there longer, being surrounded by brilliant staff that has a very academic side,” Fisher said. “You’re living in a cloistered atmosphere … You conform more.”
When Powell became chairman of the Fed in early 2018, the central bank was trying to tighten monetary policy, in part because the economy had finally rebounded to close-to-normal growth and low unemployment. By mid-2018, the Fed had hiked rates from zero to roughly 2.5%. But later that year, when Powell threatened to take his foot off the QE gas pedal, was when the markets went haywire and the president went ballistic. The Powell Pivot put that headache to rest.
During the COVID crisis, of course, the Fed again pumped trillions of dollars into the market and kept rates pinned at zero. Even in mid-2021, the necessity of tightening or normalizing it seemed like a distant problem. Then, as price increases ramped up, Powell initially telegraphed a lack of concern, calling it “transitory,” a misreading of the situation that now hangs around his neck. Instead, inflation spread deeply throughout the economy and began to gather heat. It hit 9.1% by June.
The fed’s core job is to kill inflation, and the only way it can do that is by tightening policy, which Powell has sworn he will do. During a speech at the Fed’s August retreat in Jackson Hole, Wyo.—after four rate hikes in the previous five months—Powell delivered a sobering and shockingly direct message: The Fed was going to hike rates and keep them high until inflation fell to its target of 2%. If this caused pain in the economy, so be it. “These are the unfortunate costs of reducing inflation,” he said. “But a failure to restore price stability would mean far greater pain.”
Powell remains under pressure—both implied and explicit—to pivot again. On Halloween of this year, Sen. Elizabeth Warren (D-Mass.) sent Powell a letter, which her office immediately made public. Warren wanted Powell to explain exactly how many jobs might be lost as the Fed tightens interest rates, and how wages might be affected. She quoted Powell’s own comments in which he said the Fed should tighten even if it leads to a recession. “These statements reflect an apparent disregard for the livelihoods of millions of working Americans, and we are deeply concerned that your interest rate hikes risk slowing the economy to a crawl while failing to slow rising prices that continue to harm families,” Warren wrote in the letter, which was cosigned by 10 other progressive lawmakers.
Warren’s letter seems to assume that Powell has a significant measure of freedom. In fact, his path involves navigating a narrow causeway between two unappealing outcomes. He can tolerate high inflation, and risk that it gathers strength and begins to rage out of control. Or he can tighten the money supply, and risk recession and possibly a financial crisis.
If left unchecked, inflation can enter a self-feeding spiral, punishing working-class and poor families as prices increase much faster than their wages. Investors, meanwhile, face their own threats: All those risky deals made during the massive “search for yield,” many with borrowed money, must be reevaluated in a world where the short-term interest rate controlled by the Fed remains at 4% or higher, rather than near zero.
Interest-sensitive parts of the economy are already being hit, with the housing market slowing down as mortgage rates hit the highest level in decades. Heavily indebted corporations face a tough environment as rate hikes increase their interest expenses. The S&P 500 lost nearly 25% of its value between January and September. An extended period of high interest rates would almost certainly put millions of Americans out of work, with unforeseeable repercussions.
Because the impact of tightening has already been so severe, many investors seem certain that Powell will eventually relent: They can’t believe that Powell’s Fed would usher in a financial crisis or a ruinous recession, even to fight inflation. When an inflation reading for October came in at 7.7%—lower than expected, but still painfully high—the Dow jumped another 1,200 points. Some of the calls for dovishness are coming from inside the house, so to speak. Before the FOMC’s November meeting, Chicago Fed president Charles Evans said that the Fed had raised rates so quickly that it might be “getting to a place where policy can plan to rest.” Fed Vice Chairwoman Lael Brainard echoed those sentiments in a separate speech.
Nonetheless, the Fed hiked rates again, at its November meeting. At the press conference afterward, Powell tried to throw cold water on any notion that he’d pivot. “What I’m trying to do is make sure that our message is clear, which is that we think we have a ways to go,” Powell said. How far is “a ways”? Powell, by his very nature, probably won’t know until he gets there. Investors, meanwhile, are stuck in the back seat, asking, “Are we there yet?” as their carsickness grows.
Christopher Leonard is the author of The Lords of Easy Money (2022, Simon & Schuster).
This article appears in the December 2022/January 2023 issue of Fortune with the headline, “Will Jay Powell blink?: Inside the Fed chair’s fight to curb inflation.”