“Talk about a mixed message,” says The Wall Street Journal. Last week the US Federal Reserve dropped the word “patient” from its interest-rate outlook. Markets had expected the wording change, which was seen as heralding an interest-rate hike in June.
But Fed boss Janet Yellen indulged in so much “caution and hedging” in her press conference – including a nod to the fact that the strengthening dollar had weakened export growth – that investors decided a rate hike was further off than they’d thought. So they “indulged in another easy-money rally”. We now might not see the first rate hike until the autumn at least.
The Fed’s fudging is hard to understand, says The Wall Street Journal. “There is ample reason” to have started raising the cost of borrowing already. The labour market is tightening fast. “The first signs of bigger wage increases” have emerged. And the stronger dollar is manageable. Exports comprise 13% of the American economy, compared to 40% in Germany.
While inflation is mildly negative, the idea that deflation is a danger because it paralyses economies is unconvincing, adds Gene Epstein in Barron’s. Many economists fear that consumers will put off purchases. But “tell that to the thriving industries who are having no trouble getting customers to buy at flat or falling prices”.
More worryingly, asset prices are at eye-popping levels. US stocks are close to bubble territory. Bonds have long since reached it, as negative yields throughout developed markets illustrate.
However, it has been nine years since the Fed last raised rates. Debt levels are at historic highs. Central banks have given economies and markets unprecedented support via both zero interest rates and repeated doses of printed cash. Weaning them off this easy-money therapy might be harder than anyone imagines.
For example, last time around, the Fed’s interest-rate hikes eventually “brought down the housing market” and triggered the financial crisis, says The Economist. Housing may not be an immediate problem – mortgage payments now account for around 18% of household income, down from 28% in 2006.
Yet the “unobservable variable is confidence”. How will dearer money “affect the animal spirits of investors and housebuyers? It is nine years since the last rise. Any change is a leap in the dark.”
“We don’t know,” says hedge-fund manager Ray Dalio of Bridgewater Associates, “exactly how much tightening will knock over the apple cart.” Nor is it clear “how exactly [the Fed] will fix things if it knocks it over”. What more can a central bank do once it has cut rates to zero and applied this much quantitative easing?
On the other hand, at least it’s clear how the Fed can squeeze out inflation if it takes off – just raise rates. All this means it’s riskier to move sooner rather than later, says Dalio. He points to 1937, when the Fed, thinking the US economy had finally shrugged off the Depression, tightened monetary policy. It set off a slide in housing and stockmarkets, battered confidence and ushered in recession.
Yet waiting to hike increases the risk of more damaging bubbles. Another blow-up in asset markets would batter financial institutions, and shock companies and households into cutting spending.
“I don’t think that real economy factors – such as inflation or growth – justify a tightening,” says Gerard Minack’s The Downunder Daily. But rates are too low for the financial economy, which is the tail that wags the dog these days.
Low rates “are encouraging financial smarty-pants to do the same sort of things that got economies into a jam in the first place”. But it’s probably already “too late to avert another crisis”, says Albert Edwards of Societe Generale. “The financially fattened goose is well and truly cooked.”