“One foot on accelerator, one on the brake”
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Posted 05/05/2022
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Not to be outdone by our own RBA’s bigger than expected 0.25% hike, last night the US Fed hiked rates by 0.5%. The market reaction, as is often the case nowadays, was somewhat confounding as everything (shares, bonds, gold and crypto) surged apart from the USD which fell substantially. The reason for the counter-intuitive surge has been put down to the fact many in the market were actually fearing a 75bps hike which Powell dismissed as something the committee was not “actively considering”…
The surge in shares on a rate hike saw a 44 year old record broken with the S&P500 rising the most on a rate hike since 1978. Indeed we have to do back to 2008 on a rate CUT to see a bigger sharemarket jump on any Fed announcement. The NASDAQ rocketed having bounced off a fall of 1.5% before the announcement to end 3.2% up, a 4.7% jump off the low!
And whilst Powell dismissed the 75bps hike, he did warn there will be two more 50bps hikes in the "next couple of meetings" and could even be more as he promised they will act "expeditiously" if inflation persists.
For some reason few seemed to be talking about the announcement that the Fed will also turn from taper to outright reduction (QT or quantitative tightening) of their balance sheet, maybe because they have put it back to 1 June to start unwinding $47.5 billion per month for 3 months and then up to $95 billion per month thereafter. The $4.5 trillion question is who own earth will buy all of these, adding more upward pressure to rates?
Of course at the same time the Fed is hiking rates in the face of inflation there remains two undeniable facts working against its success. Firstly, much of the inflation we are facing is due to supply chain tightness not so much demand. Powell himself admitted last night "Our tools don’t really work on supply shocks, our tools work on demand."
Secondly, and as presented by economic commentator Tarric Brooker (@AvidCommentator) in this article:
“As governments continue to inject cash into the economy at the same time that central banks are attempting to remove it through raising interest rates. We are effectively left with a series of policies that is akin to having one foot flat to the floor on the accelerator, while the other is hard on the brake.
This strategy is what I like to call burnout economics. Just like a car doing a burnout results in smoke, noise and not a whole lot forward momentum, so too does these two forces acting against each other.
As lockdowns continue in China and the war continues to rage in Ukraine, raising rates high enough to drive inflation down to the level consistent with central banks’ targets was always going to be challenging. By adding additional spending at a time when inflation is already running at multi-decade highs, that challenge becomes even harder.
The more cash that is injected into the economy by governments attempting to cushion the blow of inflation, the more central banks may need to raise interest rates in order to counter rising inflationary pressures.
In Australia, interest rate futures markets continue to price in an extremely swift and large rate rise cycle from the RBA. Up until relatively recently, few mainstream economists shared its viewpoint that this would come to pass.
But with inflation rocketing far higher than expectations, all of sudden one has to wonder, what if the market is even partially right about an aggressive rate rise cycle being necessary to tame inflation?”
Monetary policy v Fiscal Stimulus, the battle is clear.
You see the dilemma right? The world is sitting on the highest debt pile in history. Individual Australian’s hold more personal debt than nearly any other country in the world. Corporate debt is sky high and the quality of it declining. Government debt sits too at records and globally around the 100% of GDP. The US is now above $30 trillion and tipped to reach 150% of GDP in a decade by its only Congressional Budget Office.
At the same time, central banks are hiking rates to control inflation, increasing the servicing cost of that debt, whilst Governments continue to add to the debt to win favour amongst those hurting (or voting…) with the inevitable inflation borne of a decade of unprecedented money printing and zero interest rates. Watch the news each night during this election campaign to see this spending. To think shares will thrive in such an environment, starting at such nosebleed valuations already, seems fanciful but who really knows what happens in such unprecedented times? What seems almost certain (should history repeat) is that rates will hike to the point of failure, may not address inflation beforehand, recession ensues, and the central banks start up the printers again and slash rates to save the day. Gold jumped last night and for good reason. The wise ‘pet rock’ has a knack of sniffing out what’s ahead.