Good news is bad news in the US econ­omy

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

‘It’s a re­mark­ably pos­i­tive set of eco­nomic cir­cum­stances,” said Fed­eral Re­serve chair­man Jerome Pow­ell last week. “And there’s no rea­son to think it can’t con­tinue for quite some time”. The US econ­omy grew at a buoy­ant an­nu­alised rate of 4.2pc be­tween April and June. New sur­vey data sug­gest that, in the wake of Don­ald Trump’s cor­po­ra­tion tax cuts, there’s more to come.

As com­pa­nies boosted hir­ing in Septem­ber, ac­tiv­ity across the ser­vices sec­tor – ac­count­ing for more than two thirds of the world’s largest econ­omy – raced to a 21-year high. “The US econ­omy is do­ing ex­tremely well,” said Chicago Fed pres­i­dent Charles Evans last week. “The fun­da­men­tals are strong”.

If that’s so, why are there wide­spread con­cerns Amer­ica’s fi­nan­cial mar­kets could soon col­lapse? And why did such fears just in­ten­sify af­ter the re­lease of eco­nomic news that the Fed­eral Re­serve boss him­self de­scribed as “re­mark­ably pos­i­tive”?

The rea­son, of course, is we’re still in the post-crash Alice-in-won­der­land world where “good news is bad news”. Signs of eco­nomic strength mean cen­tral banks could cur­tail, sooner rather than later, the ul­tra-loose mone­tary pol­icy that’s pre­vailed since the 2008 cri­sis.

That, in turn, spooks fi­nan­cial mar­kets – bloated af­ter years of in­ter­est rates nailed to the floor and hav­ing gorged on the drip-feed stim­u­lant that is quan­ti­ta­tive eas­ing. In­vestors have bor­rowed heav­ily over the last decade, so fi­nan­cial mar­kets are highly “lever­aged”. That makes them prone to sharp down­ward lurches as share-price falls mean loans are called in, with in­debted in­vestors then forced to dump stocks at any price. The US stock mar­ket reg­is­tered dou­ble-digit gains in five of the past 10 years, soar­ing by 25pc in 2017. Val­u­a­tions are flash­ing red. The S&P’S 500, the bell­wether in­dex of lead­ing shares, is now priced higher, as a mul­ti­ple of an­nual earn­ings, than just be­fore the 2008 col­lapse.

The Fed has al­ready cur­tailed QE, of course – bring­ing Amer­ica’s vir­tual money-print­ing pro­gramme to an end back in late 2015. Since then, though, the Euro­pean Cen­tral Bank and the Bank of Ja­pan have car­ried the QE ba­ton, chan­nelling the equiv­a­lent of tens of bil­lions of dol­lars into global mar­kets each month, keep­ing stocks ev­ery­where pumped up.

The Fed has also led the charge on in­ter­est rates, im­pos­ing eight suc­ces­sive rises, in quar­ter per­cent­age point in­cre­ments, since US QE ended. The pace has lately quick­ened, with the last three Fed in­creases com­ing this year, in­clud­ing last month – the lat­est 0.25pc move tak­ing the bench­mark to 2pc-2.25pc.

So far, with cen­tral bankers in Frank­furt and Tokyo keep­ing the QE sluice gates open, US fi­nan­cial mar­kets have ab­sorbed this grad­ual tight­en­ing of in­ter­est rates. What’s now changed, though, is the tone of Pow­ell’s rhetoric.

As re­cently as late Au­gust, at the Wy­oming Jack­son Hole sum­mit, the Fed supremo talked of mov­ing “con­ser­va­tively”, not­ing that “when un­sure of the po­tency of a medicine, start with a some­what smaller dose”. Such dovish words re­as­sured in­vestors rates wouldn’t rise too far too fast.

But over the past month, as the US econ­omy has strength­ened, Pow­ell has changed his tune. “In­ter­est rates are still ac­com­moda­tive,” he said last Wed­nes­day, “but we’re grad­u­ally mov­ing to a place where they’ll be neu­tral” – that is, nei­ther re­strain­ing nor boost­ing the econ­omy. “We may go past neu­tral,” Pow­ell con­tin­ued, “but we’re a long way from neu­tral at this point, prob­a­bly”.

Don’t fret if that sounds like gob­bledy­gook. Talk­ing in el­lip­ti­cal rid­dles is what cen­tral bankers do. If you’re not con­fused, you don’t re­ally un­der­stand what’s go­ing on. The thrust of what Pow­ell is say­ing, though, is that rates will not only keep

ris­ing, but may go up faster than pre­vi­ously as­sumed. And that’s why global fi­nan­cial mar­kets, which have long been pre­car­i­ous, are this week­end doused in doubt.

Fi­nan­cial an­a­lysts tend to fo­cus on the va­garies of the stock mar­ket, be­cause that’s where the bulk of most peo­ples’ in­vest­ments are. But bond mar­kets are also mas­sively im­por­tant – see­ing as they gen­er­ate the in­ter­est rates that de­ter­mine the ac­tual cost to con­sumers, firms and coun­tries of both fresh bor­row­ing and ser­vic­ing ex­ist­ing debt.

Last week, as spec­u­la­tion mounted that the Fed might up the pace at which bench­mark rates are in­creased, the US 10-year Trea­sury yield hit a seven-year high – go­ing above 3.22pc for the first time since 2011. And as the Fed keeps rais­ing the bench­mark, such mar­ket in­ter­est rates could spi­ral up­ward much more – se­ri­ously desta­bil­is­ing global com­merce, as both stocks and bonds be­come less at­trac­tive.

Stronger US growth means in­vestors de­mand higher yields to lend money to firms and the govern­ment, push­ing bond prices down. That’s partly be­cause other op­por­tu­ni­ties look more at­trac­tive as the econ­omy ex­pands. But the main rea­son is that growth tends to push up in­fla­tion – which means the fixed “coupon” that most bonds reg­u­larly pay be­comes less valu­able in real terms.

Pow­ell says “an in­fla­tion sur­prise to the up­side … isn’t in our fore­casts”. Such cir­cu­lar logic from the Fed doesn’t con­vince. With un­em­ploy­ment down at just 3.9pc, and the em­ploy­ment-in­ten­sive ser­vice sec­tor boom­ing, US wage pres­sures are ris­ing. Ama­zon’s de­ci­sion last week to in­crease its low­est wage to $15 (£11.47) an hour, well above the $7.25 fed­eral min­i­mum, was par­tially driven by crit­i­cism spe­cific to the tech gi­ants. But it points to a broader trend of firms strug­gling to re­cruit from a tight­en­ing labour mar­ket.

US in­fla­tion has av­er­aged 2.7pc over the last six months. Ris­ing wages and dearer oil – Brent crude is now above $80 a bar­rel – could see it go much higher. With the ECB set to wind down QE later this win­ter, an­other large cen­tral bank will with­draw from the emer­gency mea­sure of buy­ing govern­ment bonds, push­ing up yields fur­ther.

The big pic­ture is that global bond yields are set to rise, driven by a boom­ing US econ­omy. That will lead to higher bor­row­ing costs ev­ery­where. Con­sider, also, that com­bined pub­lic and pri­vate debt across the world now stands at $182 tril­lion ac­cord­ing to the In­ter­na­tional Mone­tary Fund – some 60pc higher than in 2008.

“I don’t think there is an alarm go­ing off,” said Bos­ton Fed pres­i­dent Eric Rosen­gren last week. “But I do think there are a lot of yel­low lights”. The era of “easy money” is end­ing – and the up­shot won’t be pretty.

‘Global bond yields are set to rise, driven by a boom­ing US econ­omy. That will lead to higher bor­row­ing costs ev­ery­where’

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