When the going gets tough, we need more
GLOBAL markets – Wall St most obviously and most importantly – have settled into a sort of “phony war” state of uneasily comfortable calm since US Federal Reserve head Jerome Powell started talking “tough” about interest rates.
The central fact that he isn’t actually talking tough is the biggest part of it. The Fed’s supposed toughness has been, is, and will continue to be, very much an exercise in a “Clayton’s toughness”.
Inflation in the US is way, way above the 2 per cent at which the Fed is supposed to keep it. Indeed it’s way, way above the 3 per cent or so that a responsible Fed might “accept” for a “while” to balance against broad recession and punishingly high unemployment.
Inflation in the US is now 8 per cent and threatening – yes, partly because of the war in Ukraine – to go higher.
But it got to the 8 per cent before the war erupted and it’s been above 5 per cent since early last year.
Further, the jobless numbers are very low and workers are seeking – and getting – wage rises of 5 per cent and higher, threatening to lock in exactly the sort of wages-prices spiral that is so damaging and so hard to stop without real and serious economic pain.
Yet what has the Fed done? It finally, finally started talking (Clayton’s) tough in January – but postponed any action on interest rates for six weeks until its mid-March meeting.
Sort of like saying, we’ll get back to you on that flood or bushfire that’s surging/raging around you in, oh well, six weeks?
And then what did he actually do at the mid-March meeting?
He raised the Fed’s official rate by a “punishing” all of 0.25 per cent; from zero to 0.25 per cent (technically, the way the Fed works, from a range of zero to 0.25 per cent to a range of 0.25 to 0.5 per cent).
Sort of like, finally arriving at the flood or bushfire with a bag of sand or a garden hose.
Oh sure, Powell is still
to get even tougher. Why, he might even think of delivering a 0.5 per cent rate hike at one of those future,
meetings.
But heck, the meetings and any rate hikes are only going to be, at best, every six weeks, so by the end of the year – if he really followed through on even his Clayton’s toughness – the official rate might be near 2 per cent.
There’s no way in the world a 2 per cent official rate could be considered anything other than wildly stimulatory – for the economy for Wall St – when inflation, as it will be still by the end of the year, is close to and maybe even above 10 per cent. So Wall St, after peaking right at the start of the year and then falling away through January and
February, as the inflation reality became more entrenched and more obvious – and into at least uncertainty about what the Fed might do – has crept back through March.
The Dow, after being down 11 per cent from the January peak, is now down by just 5 per cent.
Our market’s done even better. Barely 2 per cent down from the early January peak.
This brings me back to the “phony war” – what happened at the start of World War II.
In September 1939 Hitler invaded Poland – and the Soviet Union, the sort of model for Putin’s current Russia, grabbed the eastern half of Poland.
But after that Hitler did nothing; there was eight months of quasipeace.
The “phony war”.
Then in May 1940 Hitler launched his blitzkrieg against France and we know what happened after that.
I suggest we’re replaying that story with the Fed.
Yes, Powell is threatening to raise rates, but as of yet he’s only raised them by
0.25 per cent. And, heck, what he’s proposing to do, stretched out through the year, doesn’t sound so bad at all.
OK, so the official rate goes to 2 per cent; when inflation is running at, say 8-10 per cent, which means corporate earnings are probably increasing at 10 per cent plus. Therefore current share values will be “underwritten” and shares will continue to look far more attractive than bonds, with interest of only 2-4 per cent. So, does Powell unleash his surprise “blitzkrieg”?
This is where the story diverges.
Wall St knows that if he did start to actually get tough – or if even his Clayton’s toughness started to cause discomfort – it just would need to throw a tantrum, such as selling the Dow down, say, 2000 points a day for couple of days, and he’d instantly back off.
Trouble is, just like the phony war couldn’t last, neither can the Fed’s Clayton’s toughness.
One way or another it will eventually implode, devastatingly.