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jeudi 16 novembre 2017

Federal Reserve gains a plumber-in-chief with Jay Powell | Joe Rennison and Robin Wigglesworth FT

Central bank chair nominee’s knowledge on structure of markets will probably be tested

On the eve of his official nomination as the next chair of the Federal Reserve, Jay Powell was addressing an industry roundtable on the efforts to move the financial system away from Libor, the disgraced global interest rate benchmark.

Although the 64-year-old’s remarks to the New York Fed were prerecorded, his willingness to dive into the minutiae of interest rates illustrates how the policymaker has embraced the nitty-gritty of financial market structure more than most since he joined the Fed board in 2012.

At some point during his stint at the helm of the Fed, Mr Powell will probably find the experience and knowledge he has accumulated in the plumbing of financial markets tested. Under the former private equity executive, the Fed will face the task of managing a turning point in policy as officials shrink a $4.5tn balance sheet the US central bank amassed fighting the financial crisis and shielding the economy from its fallout.

While Janet Yellen has gingerly begun this task, Mr Powell will continue the retreat with US corporate bond markets trading near record highs and stocks reaching new peaks. The big concern for investors is that as the Fed — and other central banks — retreat from QE, changes in how securities are traded, namely how capital-constrained banks are reluctant to act as market makers in bonds and credit, raise the risk of a major shock in financial markets.

“In the environment that we are in now, having someone who understands the plumbing of financial markets is very positive,” says Nathan Sheets, now chief economist at PGIM Fixed Income after a stint at the Treasury, where he worked closely with the central bank official. “Governor Powell certainly fits that bill.”

Mr Powell, who will also have a slew of fresh governors, including a new head of the New York Fed after Bill Dudley said on Monday that he would be leaving next year, has voiced optimism that a gradual reduction in the Fed’s holdings of Treasuries and mortgage-backed securities will be orderly. However, he has also warned that the fragility of an outdated market structure — yet to fully adjust to a new breed of tech-savvy traders that have become more prominent in the $14tn US government bond market — may spell problems.

“Most of the time in most markets liquidity is OK. But it may be more fragile, and more prone to disappearing in stress situations,” he told the FT last year. “There hasn’t been a liquidity-related incident that has had a significant effect on the real economy. That doesn’t mean it won’t happen.”

As a Fed governor, his interest derives from the central bank’s responsibility to ensure stability of the financial system, where Treasuries are the chief source of collateral for many institutions and clearing houses which back vast amounts of derivatives trading. US government debt also plays a key role in portfolios for domestic and foreign investors. He has voiced support for central clearing of “repo” trades that are integral to the functioning of the broader Treasury market.

“He has shown a strong interest in this part of the market and so we are optimistic and confident that will continue,” says Paul Hamill, global head of fixed income trading at Citadel Securities. “We feel strongly that there are some sensible things that should be implemented.”

But it is an interest that is also rooted in his experiences as an undersecretary in the US Treasury in the early 1990s, when he sat on a committee probing Salomon Brothers after the investment bank sought to rig Treasury auctions and was fined for infractions of the rules. The episode “still gives me nightmares”, Mr Powell said last month.

Some Fed observers pointed to Mr Powell’s willingness to re-assess capital requirements and rules implemented since the financial crisis, such as the Volcker rule that prohibits banks from proprietary trading, as sharpening his appeal to a White House that has vowed to de-regulate. He has also shown an openness to tweaking stress tests and regulation for small banks.

Yet some of his views, such as the possibility of introducing rules to slow down trading in US government bonds to prevent unexpected bouts of market volatility like the one-day “flash rally” of October 2014, may be out of step with a Trump administration that wants less regulation, not more.

Overall, Mr Powell’s approach has typically been to encourage industry participants to drive change, rather than rush to write more rules, and he is seen as a pragmatist that engages with financiers.

He set up the Alternative Reference Rates Committee, an industry body tasked with transitioning financial markets away from the Libor benchmark. He has also taken an active role within advisory groups to the US Treasury, such as the Treasury Markets Practice Group.

“Powell understands about those market mechanisms and would be willing to get on the phone with a banker,” says Vincent Reinhart, chief economist at Standish Mellon, who worked closely with Mr Powell in the early 1990s. A member of a Treasury advisory committee agrees, saying: “Versus a lot of other people that were thrown out there, this guy is the most rational.”

A background that leans towards markets, rather than the academic study of economics, worries others. He will be the first non-economist to run the Fed since the brief, ill-fated reign of G. William Miller in the 1970s.

“We are not sure how it is going to work to have a non-economist go before Congress and take questions on the highly technical and complex role that monetary policy plays in our economy,” says Chris Rupkey at MUFG. “We wish Mr Powell well in his role of Fed chairman, but for the markets there could be some rough seas ahead.”

His stint as a Fed governor suggests Mr Powell is well aware that markets can be volatile. “Markets, however, can turn on a dime, and reactions can be outsized,” he said in a speech on emerging markets last month.

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