Let’s base our de­ci­sions on re­al­ity

Try­ing to give guid­ance on rates well in ad­vance can have un­in­tended ef­fects, by in­creas­ing un­cer­tainty

Financial Mail - Investors Monthly - - Futures Imperfect - RON DERBY

Next month, the hol­i­day mak­ers in the First World will re­turn to their desks in the fi­nan­cial houses in New York and Lon­don, pre­pared for the nor­mal­i­sa­tion of mon­e­tary pol­icy in the world’s big­gest econ­omy.

The US Fed­eral Re­serve has laid the foun­da­tions for it for the bet­ter part of two years and when the north­ern sum­mer va­ca­tions be­gan, there was very lit­tle doubt that next month we’d see the first rate hike since 2006. The US econ­omy is strong and un­em­ploy­ment, which is a ma­jor con­cern of its cen­tral bank, sits just above 5%.

These fac­tors point to a rate hike and a nor­mal­i­sa­tion of mon­e­tary pol­icy in the US. And if they come about, SA’s con­sumer mis­ery will con­tinue, as the South African Re­serve Bank, whose mon­e­tary pol­icy com­mit­tee also meets next month, will no doubt have to fol­low suit.

Higher rates in the US will in all like­li­hood only strengthen the dol­lar fur­ther and by ex­ten­sion only worsen our in­fla­tion out­look.

So that’s our im­me­di­ate fu­ture — well, per­haps.

There’s another pos­si­bil­ity, one where the Fed con­tin­ues to hold back on nor­mal­i­sa­tion. Apart from the fact that more Amer­i­cans are em­ployed, there’s still no in­fla­tion to speak of.

A healthy re­cov­ery in the US econ­omy — or any econ­omy — is nor­mally ac­com­pa­nied by higher in­fla­tion as de­mand picks up. In the case of that coun­try, whose econ­omy is largely made up of do­mes­tic con­sump­tion, a rise in de­mand should be vis­i­ble rather quickly through ris­ing prices.

This is def­i­nitely not the case. In­fla­tion in the US is com­ing in around 0,1%, much lower than the Fed’s 2% tar­get. A sign, if ever there was one, of just how tepid the US eco­nomic re­cov­ery still is. Stan­dard Char­tered says the cur­rent US eco­nomic cy­cle may have peaked.

There is room for the Fed to wait and come back to the most awaited de­ci­sion in global mar­kets in De­cem­ber, per­haps. Or even 2016.

Which brings me to my one is­sue with the world’s cen­tral banks and their habit since 2008 of try­ing to man­age mar­ket volatil­ity by giv­ing long-term guid­ance on what their mon­e­tary pol­icy will be. It al­lows the op­po­site to hap­pen, es­pe­cially if their moves are re­liant on eco­nomic data.

The data does shift the goal­posts from time to time. From month to month, week to week and in some cases, day to day, they tell a dif­fer­ent story. And cen­tral bankers and their com­mit­tees should have the space to change their minds.

But when they’ve in­formed mar­kets that in 18 months, they’ll ei­ther tighten or loosen mon­e­tary pol­icy, they tend to paint them­selves into a cor­ner. Their cred­i­bil­ity will be ques­tioned if they don’t fol­low through.

The Bank of Eng­land’s Mark Car­ney promised nor­mal­i­sa­tion in the UK econ­omy as soon as the un­em­ploy­ment tar­get was reached. Well it was, in the first quar­ter of last year. But rates haven’t moved (and rightly so).

Cen­tral bankers should play it by ear and re­lax on this need for long-term guid­ance in an at­tempt to cool volatil­ity in mar­kets. If any­thing, this has only fu­elled the un­cer­tainty.

In search of global growth and di­rec­tion, mar­kets have looked for guid­ance from the world’s lead­ing cen­tral bankers, let­ting them as­sume an “or­a­cle”-like role. We now know that growth is no longer in their hands, for most of the world’s gov­ern­ments need to face up to struc­tural changes in their do­mes­tic economies.

To get out of the spotlight and al­low them the time and space to make their calls on mon­e­tary pol­icy with­out mar­ket pres­sures, cen­tral bankers need to keep their ears to the ground and ad­vise on a shorter-term out­look.

Maybe, just maybe, the Fed will be able to nor­malise when in­fla­tion data tells it to. Not when it’s to meet a prom­ise made two years ago.

But any­way, ei­ther next month or in De­cem­ber, the great nor­mal­i­sa­tion be­gins. And we, mere mor­tals, liv­ing in the emerg­ing world, will hope we come out okay when a new nor­mal is reached.

Welcome back, New York and Lon­don.

Cen­tral bankers should re­lax on this need for long-term guid­ance in an at­tempt to cool volatil­ity

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