Mountain to climb for world’s central bankers
All eyes on Federal Reserve chairman at Jackson Hole as spooked markets scramble for clues on further rate cuts, reports Tim Wallace
The great and the good of central banking gather this week in the rustic holiday resort of Jackson Hole, Wyoming. Lakes, rivers and a stunning mountain backdrop will greet the policymakers in the Cowboy State as they escape Washington DC and other political centres where the heat is rising.
Trout fishing is a particular draw at Jackson Hole. In 1982 the Kansas City Fed wanted to bring Paul Volcker, chairman of the US Federal Reserve, to the event. But how to persuade him to travel the 2,000 miles from head office to a conference halfway across the US? With a fly and tackle, of course. Volcker, a keen angler, was happy to attend and the bash has become a fixture of the economic calendar.
This year the officials in attendance have even bigger fish to fry than usual. The apparent impending economic crunch should concentrate minds.
Recessions are usually a surprise, wreaking havoc on livelihoods, businesses and markets that were ill-prepared for their arrival. The next apparent downturn has been well-flagged, however. Scarred by the
financial crisis, economists, policymakers and businesses have been on high alert for the past decade.
Central banks have built up big, new departments focusing on financial risks, scouring the world for hazards and potential bubbles that could cause trouble. Government departments, banks and big businesses are the same.
As a result, warnings of the dangers of years of ultra-low interest rates have been almost constant. Economists have watched shares, bonds and property rocket in value, fuelled by cheap debt, and warned that a crash back to Earth is inevitable when interest rates rise.
Sources of political instability such as Brexit have further raised the alarm. The rise of China has created a whole new set of recession risks, too. The US is fertile ground for panic: a fiscal spending spree fading, Donald Trump’s trade war tearing up the old certainties of globalisation and political conflict rife.
The result is a well-advertised economic slowdown across much of the world. Standard & Poor’s estimates there is a one-in-three chance of the US entering a recession in the next 12 months. Global institutions such as the IMF have slashed growth forecasts.
So a slump, and maybe a recession, would not be a surprise. The question this week is: what will central banks do about it?
Jerome Powell, now in Volcker’s chair at the Fed, will take centre stage. The theme of this year’s event is “Challenges for monetary policy”, which, given the backdrop, might seem a tad tame.
But in the circumspect language of central banking, this is a very clear warning that something is wrong in the world economy.
Powell has moved cautiously so far. He has made one modest interest rate cut to calm markets and the occupant of the White House. As the first in a decade, markets viewed it as a watershed and anticipate rate cuts at all remaining policy meetings this year. The chairman is not committed to that, in part because some risks, such as the trade war, are highly unpredictable. A sudden outbreak of peace and the restoration of trade flows could change his calculations drastically.
But as the tariff conflict intensifies, economists increasingly expect a change of tone and will be watching closely on Friday.
“Will Powell take the opportunity to be a bit more honest about what is driving the Fed to ease – other central banks’ relative policy and especially Trump’s fiscal excesses? A real turn lower in the US dollar likely requires the Fed to cut more sooner and restart massive QE [quantitative easing],” said John Hardy at Saxo Bank.
“Is Powell ready to go there and re-enact Bernanke’s famous 2010 Jackson Hole performance (which pre-announced QE2) or will he remain behind the easing curve?”
It is not too late for Powell to save the day, according to John Normand at JP Morgan. “The US expansion looks salvageable because a few Fed rate cuts have been able to reverse previous growth slumps (1987, 1995, 1998, 2016), as long as the US private sector hadn’t been over-leveraging when a shock hit,” he says.
The bigger problem may be in the rest of the world, where monetary policy is already working flat out, often with sub-zero interest rates, but growth has not taken off. Someone other than central bankers will have to take up the slack.
The European Central Bank’s Benoit Coeure, Philip Lane and Sabine Lautenschläger are in attendance, yet “the essential policymakers may not be in the room”, says Normand.
“Hopes are emerging that next week’s Jackson Hole symposium will spawn creativity because Europe and Japan require it, but without fiscal or structural commitments, it might be hard to translate Wyoming’s policy papers into transformational policy and market reversals.”
It is not only the rich world that needs to pay attention to Powell’s words. The Kansas City Fed’s careful notes on the event contain hints of the reasons why.
Central banks’ actions “have implications for capital markets and financial flows”, it says. Decoded, this means “look out for wild swings in asset prices and floods of cash out of struggling economies”.
“Shifts in monetary policy in one country can create spillovers through financial markets affecting others,” it notes, particularly pointing that one at
‘Will Powell take the opportunity to be a bit more honest about what is driving the Fed to ease?’
‘A real turn lower in the US dollar likely requires the Fed to cut more sooner and restart massive QE’
emerging markets. That is to say, when US interest rates rise, cash floods out of emerging markets and into the US, as investors can get better returns in a safer market, trashing investment levels and currencies.
On the other hand, when US rates are slashed it can lead to flows of “hot money” back into those emerging markets, potentially short-lived investments that have dramatic effects on exchange rates, asset prices and financial stability.
If markets have priced in plenty more rate cuts, the immediate risk is that Powell offers too few – pushing up the dollar, making emerging markets struggle to pay Us-denominated debts, and offering little extra support for the world’s biggest economy.