5 key questions for new Federal Reserve Chair Jerome Powell that will be crucial for stocks

Thomson Reuters

• Jerome Powell faces two days of congressional testimony this week, his first as Federal Reserve Chair.
• Uncertainty about Fed policy and the direction of its new leadership were factors in the global market selloff that has sharply boosted the volatility of stock and bond prices.
• Key questions for Powell include his views on how to fight the next recession, his level of concern about inflation, and his views on the labor market's strength.

This is a big week for global financial markets, which are still finding their footing after a sudden bout of volatility swept stock prices lower. Investors are eagerly awaiting new Fed Chair Jerome Powell's first congressional testimony on monetary policy and the economy beginning on Tuesday.

Powell's testimony is key for Wall Street because a big factor in the selloff was the prospect the Federal Reserve, faced with possible inflation pressure emanating from a large tax cut and a sharply higher budget deficit at a time of low official unemployment, might decide to raise interest rates more aggressively.

Bond yields have risen steadily in recent weeks, sparking concern about interest rate risks for corporations and consumers that have depressed equity prices and other risk assets.

Against that backdrop, here are five questions lawmakers should ask Powell during his two days of testimony, before the House Financial Services Committee February 27 and the Senate Banking Committee March 1:

What is the bigger risk - that inflation will overshoot the Fed's 2% target or that it will continue to undershoot it, as it has for most of the last decade?

US inflation has fallen short of the central bank's official target for most of the economic expansion that began in the summer of 2009, following the worst recession in generations. Yet a couple of recent readings on wages and consumer prices exceeded Wall Street expectations, helping generate a selling frenzy in global stock markets that caught many by surprise.

Powell would certainly calm markets if he signaled the recent pick up in inflation is something he welcomes rather than fears, given the long-run trend of falling below target. Inflation that is persistently too low tends to signal an economy that is operating below potential and is too tepid to generate substantial wage gains for most workers.

How do you intend to communicate shifts in monetary policy and would you consider holding press conferences at all of your eight meetings each year rather than just quarterly?

Adding to the market's uncertainty, the replacement of Janet Yellen at the central bank's helm and other key leadership changes have raised questions about the Fed's center of gravity. Powell has been a Fed governor since 2012, but his views on monetary policy remain tenuously understood by market and Fed watchers. Until now, he's played a largely ancillary role.

Now that Powell is the head honcho, everybody wants to know how he feels about the nitty gritty issues involved in the setting of interest rates. Yellen's views were much clearer because of her background as a monetary economist and long-time service as a Fed president, board vice chair, and finally chair.

Her departure, in addition to high levels of turnover in other top roles, have left the central bank without a chief messenger. It's time for Powell to not only take on that mantle, but also to explain how he intends to "pursue ways to improve transparency both in monetary policy and in regulation," as he signaled at his swearing-in ceremony.

How do you view the Fed's various policy tools - the federal funds rate, forward guidance, and asset purchases - and when is it appropriate to use each one?

One of the Fed's biggest worries is not having enough tools to address the next recession given the still-low level of interest rates, which after five hikes starting in December 2015 are now in a 1.25%-1.5% range. Officials worry they will again face the dilemma of the "zero lower bound" - official rates will be cut to zero fairly quickly in a downturn, again forcing the Fed to employ measures like bond purchases, seen as unconventional.

Powell's views appear to have shifted over time from skepticism of so-called quantitative easing or QE to a stronger embrace of the policy. "Would you be comfortable resorting to asset purchases, or do you continue to have some reservations about their effectiveness?" Steven Friedman, senior economist at BNP Paribas Asset Management, asked in a research note.

What is your view on the possibility of reviewing the Fed's inflation targeting framework, as has been proposed by many economists and some central bank officials?

Another potential way to deal with the problem of hitting zero on interest rates too soon is to change the Fed's underlying framework, which since 2012 has been officially built around a 2% inflation target. Possible ideas for changes include a price-level target or a higher inflation target altogether, which are aimed at preventing borrowing costs from falling so low to begin with. Janet Yellen had signaled an openness to discussing such changes in the future toward the end of her term.

Why not hold off on any further interest rate increases until there's more evidence the economy is at full employment and wage growth picks up more consistently?

Some economists and Fed officials believe the US job market has further room for improvement despite a 17-year low jobless rate of 4.1%. They point to weak labor force participation, a lack of sustained wage growth, and the prevalence of fleeting, low-pay jobs despite one of the longest economic recoveries on record.

If they are correct, the Fed has room to remain patient and potentially hold off on further tightening of monetary policy. Any questions lawmakers can pose about Powell's views on the true strength of the employment outlook would be highly informative.