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More interference on the Fed's long road to normalisation

Peter Warnes  |  24 Aug 2018Text size  Decrease  Increase  |  
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Global central banks have a long and winding road to normalisation of monetary policy and their balance sheets. Their post-GFC stimulatory programs distorted financial markets. The US Federal Reserve (the Fed) is first cab off the rank and has begun the journey, raising interest rates seven times and begun selling assets accumulated in the unprecedented period of quantitative easing.

The dual normalisation process is unusual and not an easy task—tightening never is. The raising of interest rates has already attracted the attention of the US President, with an initial “not thrilled” tweet and he followed up by saying he expected Jerome Powell to be a “cheap-money Fed chairman”. Donald Trump has found a supporter in his most recent adversary, Turkey’s President Recep Tayyip Erdogan. Erdogan has also openly criticised the Turkish central bank, which lifted rates sharply to defend the plummeting lira, courtesy of a clash with the US President. In his words, “interest rates are the mother and father of all evil” and sees himself as “an enemy of interest rates”.

But the independence of the central bank is sacrosanct, certainly in the western world, and financial markets will not tolerate political interference, no matter from how high it comes. Despite the President’s pleas, Powell will not be a pushover and his resolve may be steeled, leading a more hawkish Fed to reinforce its independent role. Backing off is not an alternative, particularly as inflationary juices appear to be surfacing with the implementation of widespread tariff increases on consumer goods threatening to add to the pressure.

The Fed’s dual mandate is to set monetary policy goals which create and foster economic conditions to achieve both stable prices (inflation) and maximum sustainable employment. Despite meaningful stimulus, inflation has dragged as technology and the rapid growth of disruptors has offset price increases. But in recent months there is evidence of a revival and the Fed must ensure inflation is contained and act accordingly with pre-emptive strikes. The maximum sustainable employment goal has largely been met.

To put the progress of the normalisation process in context, the US Fed is the only major central bank seriously on the move. The seven-year stimulus period, where rates were cut to zero and some US$3.6 trillion in assets were purchased to inject liquidity into the financial system, will likely take at least seven years to normalise. The seven hikes in the federal funds rate from December 2015’s 0.00%–0.25% to August 2018’s 1.75%–2.00%, still sees the rate well below the 5.7% average between 1972 and 2018. And the Fed has so far sold only US$190bn of an estimated US$3.6 trillion of assets. From August 2018 the monthly rate of sales increases to US$50bn or US$600bn per year.

More tweets and comments have flowed recently with the President moving to dangerous ground saying, “the Fed should be doing what’s good for the country”, the implication being raising interest rates is not. “Am I happy with my choice (of Powell)? I’ll let you know in seven years”. These comments verge on the intimidatory, reminiscent of behaviour on The Apprentice.

The minutes of the August Federal Open Market Committee meeting reveal risks and support for further hikes. Members see trade tension between the US and its trading partners as a “potentially consequential downside risk” to an otherwise favourable outlook. As I mentioned a few weeks ago, a major escalation could interrupt the Fed’s gradual normalisation process. The jury is still out as to whether a trade war would be in the best interests of the US.

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The European Central Bank will cease buying assets in December. Then probably a hiatus, before a period of raising rates and then embarking on the great balance sheet unwind. Another seven years before normalisation.

But it looks like the Bank of Japan (BOJ) has taken the cake. The Fed, the ECB and the Bank of England were all open about their asset-purchase programs. They purchased debt instruments—sovereign bonds, corporate bonds and mortgage-backed securities. This injection of liquidity, at first a trickle and then a torrent, supported global equity markets. Investors became addicted and reacted violently when there were mooted signs of withdrawal.

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Peter Warnes is Morningstar's head of equities research. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

 


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is Morningstar's head of equities research.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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