Fed should act like parent, not teenager’
The US Federal Reserve needs to “act like the parent, not the teenager” after appearing to be increasingly swayed by the whims of the financial markets.
That’s what delegates at the Bermuda Captive Conference heard as two economic experts exchanged views on global events and markets.
They were also told that Alan Greenspan, who was chairman of the Fed Reserve from 1987 to 2006 — the second-longest tenure in the position, would be “disgusted” by the position the US central banking system finds itself in today.
Those opinions were shared by Henk Potts and Daragh Maher, the speakers at the Economists’ View session at the conference, which was held at the Fairmont Southampton.
On the one hand, investors don’t need to panic as the next recession still looks to be on the distant horizon, according to Mr Henk, an equity strategist with Barclays, as he gave an overall view on financial conditions.
He acknowledged there is a “a lot of turbulence”, such as the trade tariff wars, signs of slowing US growth, policy mistakes and social unrest in a number of countries.
Mr Maher, HSBC’s head of FX strategy in the US, was not so upbeat and said there is cause for worry.
He said: “We have US equities at or close to all-time highs, US treasuries not far off all-time highs in context of price and low yields. At he same time we have gold for the most part doing really well. So, all things that should not be moving in the same direction are all bid.
“Either people don’t have a clue, or people are worried and are buying treasuries and gold, but are also truly confident that we can be rescued. That’s what we should be worried about.”
Mr Maher said there is a “huge presumption” about the effectiveness of central bank policy, and that they will ultimately rescue investors from whatever they might face.
“Given the starting point for central banks, that’s a big leap to make. That’s where the wheels come off,” he said.
“If there is reason to be nervous it is that lack of policy response if things are truly as bad as some in the market are suggesting.”
More meat was added to the argument when the discussion zeroed in on the US economy, and a shared view that it was not going to do spectacularly well or spectacularly badly.
Mr Daragh said that being the case, it was curious that the financial market has come to the conclusion “that we are teetering on the brink of something horrific in the US”.
He cautioned that one of the signals touted as foreshadowing such a thing is the inverted yield curve on bonds. Mr Maher said it is a different environment today than in the past, due to quantitative easing and the “tightening and messing with the balance sheet”.
He said: “The signal is muddied from the yield curve, but also it reflects the financial markets — they hate the idea that nothing was going to happen.”
Mr Maher said the Fed in December had decided it was going to raise rates three times this year, but then said it was not going to do very much at all. For a while the financial markets accepted that change of sentiment.
“Then very quickly they said ‘No, we think you are going to have to cut — and cut really quite quickly and aggressively’,” Mr Maher said. The Fed responded that it might do so, but would first wait to see if the [economic] numbers got worse.
“There is an impatience and immaturity in the financial markets that always something needs to be happening; the Fed cannot do just nothing,” Mr Maher said.
“It is going to be very important for the Fed communication not to let the tail wag the dog. At the moment, and in December, that’s what happened — the financial markets said ‘Here is how we think you should be behaving. You should be a lot more dovish than you are right now,’ and the Fed finally capitulated.
“Now the markets are saying again ‘Hey, we think you should cut really aggressively’. I think it’s for the Fed to behave like the parent rather than the teenager and say ‘actually no, we are looking at the data, we are going to wait, we have told you what we are doing’.
“Whether that plays out, at the moment there is a risk that the financial markets always get their way. The Fed needs to regain the agenda and drive market expectations, rather than market expectations driving the Fed.
Mr Potts agreed, and said: “Alan Greenspan would be absolutely disgusted by the position the Fed finds itself in today.
“There has been such a dramatic change in communication that we have seen from the US central bank.”
The Fed has hiked rates nine times since the end of 2015, most recently in December.
Mr Potts said the Fed had at the end of 2018 continued to normalise its policy in response to the US economy’s strong growth profile and tight labour market. That left it with “ammunition for the next time there is an economic downturn”.
He said: “Maybe we should ask what has changed so substantially over the course of the past few months. Now the Fed points to risk for the global economy from trade wars, they point to tighter financial market conditions. Inflation is still benign in the US.”
He had heard some analysts mention the potential for a 50 basis point rate cut as early as next month, and that markets have been pricing this in, and that there could be another 25 basis point cut in September.
Mr Potts said there has been significant change in market expectations around the Fed, and added: “I find it bizarre that they have got themselves into this position.”
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Ada Foggo (1928-2020)
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