Policy U-turns from the Fed and ECB are cascading around the world
Abrupt changes in the policies of the world’s largest central banks have rippled through smaller economies, leaving them with the prospect of low and even negative interest rates for years to come despite having mostly healthy economies.
The danger is that these easy-money policies could fuel destabilizing bubbles in real estate and other asset markets. They may also leave banks with little ammunition to respond to the next economic downturn.
Economies like Switzerland’s, whose central bank signaled no change in its negative-rate policies for years to come, are small compared with the U.S. and eurozone. Still, they are home to major global banks and companies that are sensitive to exchange rates and financial conditions. With financial markets so interconnected, problems in small countries can quickly spread to larger ones.
.. The Swiss National Bank said Thursday that it would keep its policy rate at minus 0.75%, where it has been since January 2015, and reduced its inflation forecast to 0.3% this year and 0.6% in 2020. The SNB cited weaker overseas growth and inflation and “the resulting reduction in expectations regarding policy rates in the major currency areas going forward.”
.. Here’s why Fed and ECB decisions matter for countries that don’t use the dollar or euro: Switzerland and countries near the eurozone but not part of it—like Sweden and Denmark—rely on the bloc for much of their exports and imports. That makes growth and inflation highly dependent on the exchange rate. Central-bank stimulus tends to weaken a country’s exchange rate, so when the ECB embraces easy-money policies as it did two weeks ago it tends to weaken the euro against other European currencies such as the Swiss franc. Because the ECB is so large, Switzerland and others can do little to offset it.
.. “They are hostage to the fortunes of what the ECB does,” said David Oxley, economist at Capital Economics.
.. “The gravity pull is very strong” from the Fed and ECB, said Sebastien Galy, macro strategist at Nordea Asset Management. “The consequence is [non-euro central banks in Europe] mostly end up importing policy from the ECB, so you end up with housing bubbles and a misallocation of capital.”
Former Fed Chair Janet Yellen: Far from retired, nowhere near done
The Fed is very close to having satisfied its maximum employment and price stability mandates and you can see that most people feel good about the economy and the Fed.
But it would concern me — President Trump’s comments about Chair Powell and about the Fed do concern me, because if that becomes concerted, I think it does have the impact, especially if conditions in the U.S. for any reason were to deteriorate, it could undermine confidence in the Fed. And I think that that would be a bad thing.
Ryssdal: Do you think the president has a grasp of macroeconomic policy?
Yellen: No, I do not.
Ryssdal: Tell me more.
Yellen: Well, I doubt that he would even be able to say that the Fed’s goals are maximum employment and price stability, which is the goals that Congress have assigned to the Fed. He’s made comments about the Fed having an exchange rate objective in order to support his trade plans, or possibly targeting the U.S. balance of trade. And, you know, I think comments like that shows a lack of understanding of the impact of the Fed on the economy, and appropriate policy goals.
What Will Cause the Next US Recession?
Three of the last four US recessions stemmed from unforeseen shocks in financial markets. Most likely, the next downturn will be no different: the revelation of some underlying weakness will trigger a retrenchment of investment, and the government will fail to pursue counter-cyclical fiscal policy.
BERKELEY – Over the past 40 years, the US economy has experienced four recessions. Among the four, only the extended downturn of 1979-1982 had a conventional cause. The US Federal Reserve thought that inflation was too high, so it hit the economy on the head with the brick of interest-rate hikes. As a result, workers moderated their demands for wage increases, and firms cut back on planned price increases.The other three recessions were each caused by derangements in financial markets. After the
- savings-and-loan crisis of 1991-1992
- came the bursting of the dot-com bubble in 2000-2002, followed by the
- collapse of the subprime mortgage market in 2007, which triggered the global financial crisis the following year
.. And one can infer from today’s macroeconomic big picture that the next recession most likely will not be due to a sudden shift by the Fed from a growth-nurturing to an inflation-fighting policy. Given that visible inflationary pressures probably will not build up by much over the next half-decade, it is more likely that something else will trigger the next downturn.
Specifically, the culprit will probably be a sudden, sharp “flight to safety” following the revelation of a fundamental weakness in financial markets. That, after all, is the pattern that has been generating downturns since at least 1825, when England’s canal-stock boom collapsed.
.. Needless to say, the particular nature and form of the next financial shock will be unanticipated. Investors, speculators, and financial institutions are generally hedged against the foreseeable shocks, but there will always be other contingencies that have been missed. For example, the death blow to the global economy in 2008-2009 came not from the collapse of the mid-2000s housing bubble, but from the concentration of ownership of mortgage-backed securities.
Likewise, the stubbornly long downturn of the early 1990s was not directly due to the deflation of the late-1980s commercial real-estate bubble. Rather, it was the result of failed regulatory oversight, which allowed insolvent savings and loan associations to continue speculating in financial markets. Similarly, it was not the deflation of the dot-com bubble, but rather the magnitude of overstated earnings in the tech and communications sector that triggered the recession in the early 2000s.
At any rate, today’s near-inverted yield curve, low nominal and real bond yields, and equity values all suggest that US financial markets have begun to price in the likelihood of a recession. Assuming that business investment committees are thinking like investors and speculators, all it will take now to bring on a recession is an event that triggers a retrenchment of investment spending.
If a recession comes anytime soon, the US government will not have the tools to fight it. The White House and Congress will once again prove inept at deploying fiscal policy as a counter-cyclical stabilizer; and the Fed will not have enough room to provide adequate stimulus through interest-rate cuts. As for more unconventional policies, the Fed most likely will not have the nerve, let alone the power, to pursue such measures.
As a result, for the first time in a decade, Americans and investors cannot rule out a downturn. At a minimum, they must prepare for the possibility of a deep and prolonged recession, which could arrive whenever the next financial shock comes.
Four New Voters to Join Fed’s Key Panel Amid Rate-Increase Uncertainty
Quartet to face greater scrutiny as 2019 additions to the policy-setting Federal Open Market Committee
James Bullard (Dove)
Dec. 7: “I’m the most dovish person” at the Fed, and “I don’t think we’re in the position now to be penciling in further increases” in short-term interest rates.
Esther George (Hawk)
Oct. 11: The “gradual normalization of policy” the Fed has been pursuing “seems appropriate,” and “the current setting of its overnight interest rate target remains below estimates of its longer-run value.”
Eric Rosengren (Hawkish)
Oct. 1: “I believe that Federal Reserve policymakers will likely need to move interest rates gradually from a mildly accommodative stance to a mildly restrictive stance.”
Charles Evans (Hawkish)
Nov. 16: “Getting to a neutral setting is probably our first-order job,” he said, referring to the process of lifting rates to a level that neither spurs nor slows growth.
.. The new group includes Kansas City Fed President Esther George, the most “hawkish” central bank policy maker in Fed lingo because she consistently supports rate rises out of concern that low borrowing costs could fuel financial instability and create inflationary risks... At the other end of the Fed policy spectrum is St. Louis Fed President James Bullard, the most “dovish” because he opposes any more rate increases as unnecessary and possibly risky to U.S. growth... In between, but on the hawkish side, are Chicago Fed President Charles Evans and Boston Fed President Eric Rosengren, both of whom have recently favored rate increases to prevent the economy from overheating and potentially fueling excessive inflation or asset bubbles.However, three of them—Messrs. Bullard, Evans, and Rosengren—have sharply shifted their policy preferences in the past based on economic developments and could do so again in 2019.
.. Ms. George is likely to support further rate rises, and she could be a leading voice for more increases even when her colleagues are less sure that is the way to go. Ms. George has consistently suggested interest rates should move higher for several years.
Mr. Bullard appears the most likely of the four to cast a dissenting vote if the Fed does raise rates as projected. He says that with inflation low and stable, there is nothing pushing the Fed toward tighter monetary policy. He’s also worried higher rates could trigger a recession at some point.