The rule for the US Fed now seems to be: don’t fight the markets
There used to be an adage in the markets: don’t fight the Fed. It didn’t pay to bet contrary to what the central bank wanted. Last Friday, US Federal Reserve Chairman Jerome Powell proved once again that that hoary old maxim had long outlived its usefulness. The rule for the Fed now seems to be: don’t fight the markets.
On January 4, at a roundtable with former Fed bosses Janet Yellen and Ben Bernanke, Powell said he’s listening closely to the market’s fears of a slowdown, that he’ll change policy if there’s a slowdown and the changes in policy could include the timeline of shrinking the balance sheet. The markets whooped with joy. An upbeat TV analyst hit the nail on the head when he dubbed the rally as ‘Goldilocks with a capital J’ -- a reference to Jay Powell. That’s because Powell signalled that the Fed ‘put’, the policy of backstopping the markets initiated by former Fed Chairman Alan Greenspan, is alive and well.
Why Goldilocks? Because all the data suggests that while US economic growth is moderating, it’s still a far cry from a recession. If the recent jobs report is any indicator, the US economy continues to be in fine fettle, with both non-farm payrolls and wage growth surging. To be sure, the US Composite PMI for December was slightly lower than the November reading, but the rate of expansion continues to be strong.
On the other hand, data from the CME FedWatch Tool shows the probability of a Fed rate cut by January next year jumped from 23 percent a week ago to around 38 percent. A sizable part of the market now believes there will be a rate cut within a year.
So the US has good growth, low inflation and a central bank that bends the knee to them every time the markets throw a tantrum. What more could the markets want? No wonder the S&P zoomed 3.4 percent on January 4. For the time being, they are at their ‘Just Right’ Goldilocks moment.
The other adage about central banks used to be that they would withdraw the punch bowl just as the party got going. These days, nobody drinks punch and central banks in the advanced economies have injected the equivalent of crack cocaine into the markets via ultra-low and negative interest rates and quantitative easing programmes. Whenever this drug-fuelled party seems to be ending, the Fed has been quick to assure the market the cocaine supply will continue. The worry for the markets this time was that Powell was made of sterner stuff than his predecessors, a fear that sent the markets plunging. At the roundtable on January 4, Powell read from a prepared script aimed at assuaging the market’s fears. The markets heaved a huge sigh of relief.
But is a global growth slowdown really imminent? The JP Morgan Global Composite Purchasing Managers Index, a gauge of global activity in both manufacturing and services, came in at a 27-month low for December. The PMI data show the slowdown is mainly in the Eurozone, which registered the slowest growth in over four years. Rather surprisingly, the overall China Composite PMI edged up in December.
What’s causing the slowdown? David Hensley, Director of Global Economic Co-ordination at JP Morgan, said the slowdown, “mainly reflected the ongoing weakness in new order intakes, especially a second fall in international trade of goods and services during the past four months. The trend in new export business will need to show meaningful signs of revival early in 2019 if global economic growth is to make meaningful strides forward in the coming months.”
That’s where the second bit of good news comes in -- the US-China trade talks start on January 7. If a deal is struck soon, that will be another boost to the markets.
It will also be a big relief to the Chinese economy. The Chinese central bank on January 4 once again cut the amount of reserves banks need to hold, freeing up cash for new lending. That’s ammunition for the war against the growth slowdown in China.
What about emerging markets? The belief the Fed will no longer be hiking rates should weaken the dollar, always a good thing for emerging markets. China’s monetary policy stimulus should also provide a temporary boost and if a US-China trade deal is reached, it will be off to the races for emerging markets.
That said, it’s worth remembering that whatever growth we have in the advanced economies has been achieved thanks to ultra-low interest rates and a tsunami of liquidity. The big question is: what happens when the cocaine pipe is withdrawn? For the markets, the mayhem in December provided the answer. Sure, the market now believes the Fed will kick the can down the road once again. But as a report from the United Nations Conference on Trade and Development (UNCTAD) underlined: “The landing is likely to be harder, and the external effects more damaging, the more prolonged the speculative spiral.”
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