Jackson Hole should be a mea culpa for central bankers
It doesn’t help that the concept of forward guidance on interest rate policy is being abandoned in favor of a reliance on meeting-by-meeting data. Something has to fill that void, so Fed Chairman Jerome Powell’s keynote address on Friday must clarify the level of risk the US central bank is willing to take with the economy to kill the inflation beast. It is simplistic to say that there is a trade-off between growth and rising consumer prices, but any response to the current situation that does not at least attempt to square the circle will not hold.
At the European Central Bank forum in Sintra, Portugal, in June, Powell admitted that “we understand better now how little we understand about inflation.” Now more candor is needed about how the inflationary monster has been so underestimated and how far policymakers are willing to go to sacrifice growth – and jobs – to tame it.
The global central bank’s response to the pandemic prevented a major recession, but the stimulus was left in place for too long. Super relaxed financial conditions, booming stock markets and asset prices should have given enough clues. To put it in military terms, mission drift combined with a lack of withdrawal planning after the invasion got us here.
Powell was adamant to Sintra that failure to control inflation expectations posed a greater threat than recession. In other words, interest rate beats will continue until consumer price sentiment improves. But what does this mean for future policy? Where is the Fed’s pain threshold to stifle economic growth and cause unemployment?
It’s the third time the Fed has tried to reduce its balance sheet, with quick reversals after the 2013 “tantrum” and another reversal in 2018 at the start of Powell’s term. Naturally, financial markets retain the sneaky impression, based on every reaction from monetary authorities since the global financial crisis, that central banks will start to kick-start stimulus again if the stock market crashes or the economy stumbles.
The world has an overly strong dollar problem, fueled by US rate hikes, and as the global economy struggles, the rising greenback will also become a drag on US growth. Reducing the amount of dollars in circulation, which the Fed is about to attempt by shrinking its balance sheet by $1 trillion a year, has potential unintended consequences.
The Fed only stopped adding stimulus in March, when it also began raising official rates from near zero. We have barely started to tighten with only 2% reduced quantitative easing purchases. The risks of making new political mistakes, blithely jumping on the past, are high.
Traders and investors are betting on an accommodative pivot. The rhetoric from Fed officials, even the so-called doves, has been surprisingly hawkish, but it has yet to reset market expectations. The US economy is still in good shape, with the exception of some worrying signs from the housing market, but a look across the Atlantic should make you think.
The ECB is in worse shape, facing much weaker growth and rising inflation due to its energy dependence on Russia. Its board is not happy, with Bundesbank President Joachim Nagel pointing out that German inflation is expected to top 10% and clearly wanting a quicker withdrawal of stimulus. The ECB only stopped adding stimulus in July, ending an eight-year period of negative interest rates. However, the euro fell below parity with the dollar, its weakest level for 20 years. Recession warnings are rife, with the Eurozone Composite Purchasing Managers Index falling below the 50 level that separates growth from contraction.
ECB President Christine Lagarde is no longer attending Jackson Hole this year, so eyes will be on whether fellow executive board member Isabel Schnabel will attend a roundtable on Saturday. In a hawkish interview with Reuters last week, Schnabel pointed to the risk of unanchored inflation expectations even if the euro zone slips into recession. She also raised the possibility that the ECB will soon discuss a run-off of its €5 trillion QE programs. This comes as Italian 10-year yields are again around 3.7%, close to the danger zone where its leverage becomes less sustainable.
The Bank of England is in a similar situation to the ECB, with inflation already in double digits and the added complication of fiscal policy having been tightened earlier this year, but likely to be much looser in the future. coming months. Governor Andrew Bailey will be in Jackson Hole but is not expected to speak. As the BOE is about to embark on the active sale of its nearly $1 trillion in QE securities, hopefully it will use its time to speak with its Fed counterparts about their experiences of increasing borrowing costs while shrinking the balance sheet.
Picking up the stimulus is tricky because money is flowing like water in the global system. Bond-buying programs in major economies have had a stimulating effect elsewhere, so the opposite must be a big risk as quantitative tightening is underway in several regions. Now that it’s time to take the punch off, let’s hope the unity shown between central banks during the pandemic is reflected – but it must start with clear communication of what went wrong, as well as what needs to be done. done to fix it.
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Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist for Haitong Securities in London.
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