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Jerome Powell, the new boss of the Federal Reserve, was in a cheerful mood yesterday.
That usually means bad news for markets.
Rates were raised again – as expected – by another quarter point, to a range of 1.75% to 2% (2%! It’s getting much harder to describe this as “near-zero” now).
And when the boss of America’s central bank says that “the main takeaway is that the economy is doing very well”, that suggests higher interest rates are in store.
Yet the overall market reaction was pretty tame…
The market’s surprisingly sanguine reaction to a hawkish Fed
The Federal Reserve raised interest rates yesterday, and signalled that it’s full speed ahead for more. The forecast (which shouldn’t be taken literally, but certainly works to indicate what the Fed members are thinking), is now for four increases this year rather than three (in other words, there’ll be another two to go). It then expects another three in 2019.
It’s no surprise that the Fed is hawkish. It should be, given where the economy is. Lots of people are in cognitive-dissonance-induced denial about this, but the US economy is doing well on any reasonably objective measure. That doesn’t mean this will continue, but for now, growth is solid, unemployment is incredibly low, and wages are picking up.
So the Fed’s desire to raise rates while the going is good (so that it can cut them again come the inevitable recession, if nothing else), is not surprising.
What I do find a little surprising, and interesting, is the market reaction. At one point, a relatively hawkish statement from the Fed would have caused panic. Yet that’s not the sense I got from the reaction.
For a start, gold didn’t tank – which is what you’d traditionally expect from a more aggressive Fed. For another thing, the stockmarket slipped a bit, but we’re talking about 0.5% here. That’s a rounding error. It’s almost as if the Fed meeting didn’t happen at all.
This is healthy. It’s very odd that the world’s investors should be sitting on the edge of their seats every six weeks or so, waiting for a man or a woman to come out and give them hints as to the future direction of interest rates. No entity should have that much influence over a free market.
Yet for as long as I can remember, really, central banks have been the focus. Politicians came and went. They got involved in the occasional war, and they tinkered with the tax code, making it more complicated with each passing year.
But what really mattered was what the boys and girls on the monetary policy committees decided to do. And all they really did, in reality, was to cut interest rates or reassure the market that they wouldn’t be going up at any time in the near future.
That’s changed. Now, there’s a sense – for the first time in literally decades – that when it comes to investment, the Fed (and its fellow central banks) are no longer the only game in town. It doesn’t feel like they are centre stage anymore. There are changes happening in the political realm that actually matter.
Politics is back – it’s messy, but democracy has the wheel again
In the US, Trump’s decisions on spending and trade matter at least as much as the Fed’s moves on interest rates. One reason the Fed is being so punchy at the moment is because all of Trump’s actions so far are inflationary. On the fiscal side, his tax cuts are inflationary (Trump may be many things, but you could never accuse him of being an advocate of austerity).
On the trade side – well, any extra barriers to trade will drive up costs. Voters probably won’t care though, because chances are their wages will go up too. And maybe even corporations won’t be as bothered as they might have been, because “overseas” is getting expensive these days too – finding pockets of the world where labour is cheap and politics is sufficiently stable to make it worth the risk of investing there is just not as easy as it once was. (Which is good, because it indicates that life is getting better for people all over).
In Britain, we have Brexit, which is giving our democracy a thoroughly good workout. You may not like the process, but these discussions all need to be had. That’s the point. We debate, we vote, we compromise. It saves us money on guillotines and buckets and mops. Everyone’s pretty much ignoring Mark Carney now because he contradicts himself every time he opens his mouth.
As for Europe – well, Mario Draghi steps up later today, but I reckon he’s starting to signal that there’s only so much he can do. He did what it took to keep the euro together back in 2012. Now it’s up to the politicians and the people to decide if they actually want to do the hard work involved to keep it together.
My view is that there are probably more practical models for a Europe that is comprised of cheerfully cooperative individuals living harmoniously on the same street, as opposed to a reluctantly-roped-together collective struggling up a mountain side. But that’s up to the voters.
Of course, our emergence from a monetary-policy-induced financial coma is not going to be straightforward or pretty. A lot of assets have grown overvalued, and it’s hard to imagine that they won’t now go the other way.
MoneyWeek regular Jonathan Compton will be giving his view on that in an upcoming issue of the magazine later this month – if you’re not already a subscriber, Sign up here.