Markets have been waiting with bated breath for the Powell pivot. When would plunging stocks, bonds, property, and GDP trigger the strike price of the Powell put as they had triggered the Greenspan, Bernanke, and Yellen Put in crashes past? When would the panic force central bankers to pivot back to loose monetary policy again?
Perhaps it was last week? The market seems to think so. Jerome Powell, Chair of the US’s central bank, made several comments after hiking interest rates that sent stocks soaring. He said rates were now neutral and that the Fed would be data-dependent going forward.
Before we dig into those two, and how absurd they really are, consider why it matters.
Over the past seven months, markets have crashed in spectacular fashion as central banks around the world announced their intention to slay inflation by raising interest rates and cutting QE.
But if those tightening policies were to end, or just end much earlier than previously expected, the market would go berserk.
Well, markets have rallied back quite a bit since Powell’s comments. But we’re not back to the Roaring Twenties. Because it’s not quite clear what happens next.
So have the central banks actually changed course? Or is this just a bear market rally?
My old co-conspirator, Callum Newman, recently asked the man you really want to hear from on this question. Former Fed insider and trillion-dollar QE henchman Joseph Wang, known as The Fed Guy, responds to the question ‘Are Markets Misreading the Fed?’ here.
To understand my own opinion, consider what actually changed last week…
The first shift was the Federal Reserve’s declaration that the monetary policy rate is now neutral. This means it is neither stimulating nor slowing the economy at the new interest rate level.
In other words, the Fed hasn’t even begun tightening yet! It has only been reducing its monetary support…
The admission that while inflation crept more than 9%, the Fed was still stimulating prices should’ve caused mass outrage. But not many people understand these things yet. Perhaps they will at over 10% inflation.
Acknowledging that policy is now neutral implies that the Fed is now going to be much more cautious about tightening monetary policy in the future. The pace and size of rate hikes is likely to be slower and lower.
This is because the blistering pace of rate hikes so far was only justified by the fact that they would merely return the rate to neutral and should therefore, theoretically, only reduce stimulus and not trigger any sort of crisis or recession.
Not that the markets interpreted it that way, crashing in record fashion.
And, unfortunately, this was indeed only theoretically so, with GDP now declining for two quarters in the US too…
All this from returning the rate merely to neutral? It’s as if the doctors have withdrawn support only to discover their patient had been relying on it.
The second revelation, which is closely related, is the end of forward guidance at the Fed.
Until now, the Fed has been clearly signalling what it’s going to do and when well ahead of time. This has proved disastrous because the Fed completely miscalculated and had to radically change its forward guidance as inflation soared. In other words, it exposed the Fed to be clueless about inflation.
It’s not just the Fed, of course, with central bankers around the world getting a shellacking in the media.
But now the US central bank is signalling that it’s going back to being ‘data-dependent’ instead. This means that policy will depend on economic statistics that come out, rather than pre-announced intentions.
The flaw in this is also obvious. Economic data is very backwards-looking. Try driving your car by looking out the rear-view mirror, and you’ll understand what’ll go wrong.
But at least this method preserves some shred of dignity for the central bank by exposing them as clueless much less often. If we don’t know what they planned to do, we don’t know how wrong they were.
The end of forward guidance also implies the Fed is now going to be much more cautious with monetary policy tightening in the future. There is the chance that data will sway the decision making more substantially than before.
Given that the economic data has been poor, this means the Fed will probably tighten less, especially if jobs data continues to disappoint.
On balance, all of this suggests looser monetary policy than previously anticipated. Which is very different from saying there will be loose monetary policy, but it’s the change from what was previously expected that matters.
But since markets have reacted to the pivot, some central bankers are declaring markets have misunderstood all of the above. The Fed will still be hiking rates a plenty, they’ve been arguing in speeches. Inflation is still raging, after all.
So which is it?
I’m not sure. But here’s what I do know. There’s nothing quite like a market crash once the market believes there’s no rescue imminent. Just remember Lehman Brothers…
Of course, in the end, there’s always a rescue coming. Fiat financial systems collapse from inflation, not deflation. The real question is how bad things get.
And so we’re right back to where we started, pondering where the Powell put’s strike price is and whether the Fed will pivot. We still don’t know. Although, with markets crashing so far this year, at least we know we’re a bit closer to it.
Strangely, central banks are the ones trying to convince you that things must get pretty darn bad before they’ll actually flinch.
Funny how times change. Not so long ago, they were guaranteeing everything would be OK.
One last thing before you go. Do you remember what happened the last time Labor proposed a super profits tax on the resources industry? Commodity prices collapsed.
I wonder if we’ve got another classic signal of a top?
Until next time,
Editor, The Daily Reckoning Australia Weekend