Rugged back­drop suits Yellen’s tough talk

The Sunday Telegraph - Money & Business - - Business - LIAM HAL­LI­GAN Fol­low Liam on Twit­ter @liamhal­li­gan

The end of sum­mer, for econ­o­mists at least, is marked by the Jackson Hole sym­po­sium. This an­nual cen­tral banker sum­mit, set in the pic­turesque Wy­oming moun­tain re­sort, is gen­er­ally of in­ter­est only to face­less fi­nan­cial in­vestors and pol­icy wonks. This week­end’s gabfest, though, is likely to at­tract more at­ten­tion.

One rea­son is that this could be the last hur­rah for Janet Yellen. The diminu­tive Fed­eral Re­serve boss, the only woman ever to hold this vi­tal post, could soon be re­placed. Her first term ex­pires in Fe­bru­ary – and pres­i­dent Trump could de­cide not to reap­point her.

In my view, Yellen has done a pretty good job. The Fed is alone among the world’s ma­jor cen­tral banks in terms of rais­ing in­ter­est rates from the ul­tralow emer­gency lev­els that have pre­vailed for al­most a decade since the sub-prime col­lapse. The US cen­tral bank has in­creased rates three times since last De­cem­ber and, while weigh­ing on mort­gage-hold­ers, this in­cre­men­tal mon­e­tary tight­en­ing helps far more nu­mer­ous savers.

By sig­nalling at least the start of a re­turn to nor­mal­ity, higher rates are a net eco­nomic pos­i­tive. And, with the US grow­ing by a rea­son­ably buoy­ant 1.5pc in 2016, and set for a 2pc ex­pan­sion this year and next, there is just no ex­cuse not to put rates up.

The ex­tent to which fi­nan­cial mar­kets hang on the words of cen­tral bankers is, of course, lu­di­crous. But be­cause ev­ery­one else is watching so closely, in­vestors have no choice but to re­act. If Yellen sounds re­motely more likely to back an­other rate rise soon, the dol­lar will rise, with eq­ui­ties prob­a­bly fall­ing. She has lately sounded “hawk­ish”, with the min­utes from the Fed’s lat­est meet­ing on mon­e­tary pol­icy not­ing that “the vul­ner­a­bil­i­ties caused by as­set val­u­a­tions are now el­e­vated”.

If the Fed doesn’t tighten soon, then over-juiced as­set mar­kets could crash. That’s why I be­lieve Yellen will sig­nal more rises, while vow­ing to start un­wind­ing the Fed’s vast bal­ance sheet – as she be­gins the re­ver­sal of that other post-lehman mea­sure, “quan­ti­ta­tive eas­ing”.

This time last year, I thought Yellen lacked the guts to raise rates. But she has. For the most part, Trump has backed these rises, mindful that QE has gone way too far and many of his core vot­ers are small-time savers sick and tired of neg­a­tive real re­turns.

Yet Yellen is now at log­ger­heads with the pres­i­dent when it comes to “fi­nan­cial sta­bil­ity” – the main sub­ject she’ll ad­dress this week­end. Trump was elected on a ticket of “not suck­ing up to Wall Street like Hil­lary”. In of­fice, though, he is back­ing a ma­jor dereg­u­la­tion pack­age, spear­headed by Steve Mnuchin, trea­sury sec­re­tary and ex-gold­man Sachs banker. The thrust of the Mnuchin ini­tia­tive is to re­verse much of what re­mains of the “macro­pru­den­tial” mea­sures in­tro­duced to stop an­other 2008-style mar­ket melt­down. The Gold­man team in the White House want to scale back cap­i­tal re­quire­ments and lim­i­ta­tions to leverage and pro­pri­etary trad­ing – moves that will be lauded by Wall Street, while mak­ing fi­nan­cial mar­kets more crash-prone. Yellen – again, to her credit – has pushed back, point­ing out the dan­gers. We could soon see Trump re­move Yellen, only to re­place her as the world’s top fi­nan­cial pol­i­cy­maker with a man from Gold­man Sachs, due to her protest­ing a set of ir­re­spon­si­ble mar­ket-boost­ing mea­sures im­posed by an­other man from Gold­man Sachs. Not a good look. As such, this Yellen-trump stand-off could yet get be­yond the busi­ness sec­tions and on to the front pages. Ex­pect Yellen, then, to toughen up her “fi­nan­cial sta­bil­ity” rhetoric this week­end, us­ing the Wy­oming moun­tains as a suit­ably rugged back­drop.

The Fed supremo, though, could yet be up­staged by Mario Draghi. The boss of the Euro­pean Cen­tral Bank will speak at Jackson Hole for the first time since 2014. In the past, Draghi has been able to ar­gue for more mon­e­tary stim­u­lus to fos­ter growth, given that the eu­ro­zone has been mori­bund.

Now the 19-mem­ber cur­rency bloc is ex­pand­ing at some­thing close to 2pc, “Su­per Mario” has no ex­cuse but to rein in his own ver­sion of QE – even if that growth is so un­even the Ital­ian econ­omy re­mains 10pc smaller than it was in 2008, with poor Greece still locked in a de­pres­sion longer and deeper than Amer­ica in the 1930s.

In July 2012, Draghi fa­mously com­mit­ted to do “what­ever it takes” to hold the sin­gle cur­rency to­gether. Since then, the ECB has doused the eu­ro­zone bonds mar­ket with QE liq­uid­ity when re­quired, a com­mit­ment vi­tal in pre­vent­ing the ill-de­signed cur­rency union from fall­ing apart com­pletely.

The com­mon im­pres­sion that the ECB be­gan QE later than the other ma­jor cen­tral banks and has used it far less is mis­taken. It is true that Draghi’s of­fi­cial QE pro­gramme was launched in Jan­uary 2015, years af­ter the Fed and Bank of Eng­land. Yet for a long time be­fore that, the ECB’S bal­ance sheet saw rapid ex­pan­sion via a com­plex mech­a­nism for set­tling pay­ments be­tween the cen­tral banks of in­di­vid­ual eu­ro­zone mem­bers known as “TARGET2”.

Ex­plicit eu­ro­zone QE was de­layed so as not to ag­gra­vate vo­cif­er­ous Ger­man op­po­si­tion. On the lat­est fig­ures, though, via overt and covert means, the ECB’S bal­ance sheet grew three­fold be­tween mid-2008 and April 2017 – from the equiv­a­lent of $1,500bn (£1,200bn) to over $5,000bn, a sim­i­lar size to that of the Fed and, in terms of eu­ro­zone GDP, even big­ger.

Now, ahead of Ger­man elec­tions next month, Draghi is un­der in­tense pres­sure from Berlin to cork his mon­e­tary bazooka. This week­end, then, he might want to scare the living day­lights out of eu­ro­zone bond mar­kets by threat­en­ing his own QE re­ver­sal, if only to keep irate Ger­man politi­cos at bay.

‘Yellen is at log­ger­heads with the pres­i­dent when it comes to fi­nan­cial sta­bil­ity, the main sub­ject she’ll ad­dress this week­end’

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