If you want to intimidate everyone, forget being reincarnated as the US bond market. Come back as the Federal Reserve instead.
Some might argue that’s because the Fed is the US bond market right now. But it’s the fear that it’s not going to be for much longer that’s got investors scared out of their wits.
The Federal Open Market Committee is set to publish its latest monetary policy decision later on today, at 2pm local time (or 7pm in London). That will be followed by a press conference with Committee chair and Fed head Jay Powell.
There are plenty of other reasons investors have been on edge ahead of the vote — the recent market volatility isn’t all about the Fed. But the suspicion that the US’s central bank will announce a sudden stop to its asset purchases, currently running at least $40bn a month for Treasury securities and $20bn for mortgage-backed‑securities, has not exactly soothed tensions. A sudden stop would, of course, imply that the Fed would begin shrinking its balance sheet by selling those assets more quickly than expected too.
Scary times for investors in the US and, indeed, beyond.
The other main element of the Fed’s policy — tightening interest rates — is a matter of great import too. Few expect the Fed to raise rates before its next meeting in March, but some have begun betting that this first move will be a 50 basis point hike. Investors are on the lookout for a hint from Grandmaster Jay that the committee would prefer a more moderate a 25 basis point rise instead. By historical standards, neither magnitude is that unusual. But these are not normal times.
We don’t think there’s that much risk of a hawkish surprise at this meeting. Some argue that if you look in the rear-view mirror and observe the US economy’s performance in 2021, then the Fed should have turned off the taps quicker. That’s probably right. The recent economic data, however, has been poor. Retail sales in the US were worse than expected. While spending may pick up as the Omicron wave passes, US consumers will feel the pinch from fiscal retrenchment this year. While it’s true that this follows a period where government spending was at war economy levels, it may be another factor that stops the Fed wanting to do anything other than expected.
Today, at least. Later this year, however, we do think that the Fed could end up having to tighten more than officials are currently letting on.
Investors might fear the Fed, but increasingly Powell and his boss Joe Biden look a lot more concerned about public opprobrium over inflation that, at 7 per cent, is at a multi-decade high and outstripping wage growth.
We still think that a wage-price spiral is unlikely and that inflation will abate once supply chain pressures ease and demand for consumer goods falls. We suspect there will be a lot more companies in the position of Peloton, with their warehouses stacked full of inventory, as the year rolls on. Never mind inflation, that build-up of inventories could even prompt prices of consumer durables to fall. But — and it’s a big but — thinking that price pressure might abate at some point doesn’t lessen the pain of poorer Americans, who are having to deal with the consequences of a cost of living crisis in the here and now.
While the Fed might not be able to do much about that in the short-term, Powell does have to show that he is aware that people are suffering and deliver on the promise that, if prices keep on going up, policymakers will prioritise doing what they can to aid Americans facing a cost of living crisis over shoring up asset prices.
The danger for investors is that, if we are wrong about inflation ebbing and right about Powell prioritising people over markets, policymakers will have to raise rates faster and higher than almost anyone is positioned for.
It is decades since investors have had to deal with a Fed actively combating consumer price inflation.
The Greenspan put — 35 this year — is emblematic of an era in which the lack of any real inflationary headwinds enabled monetary policymakers to provide the sort of cheap and plentiful supplies of credit that has kept asset prices high. Since 2008, policymakers could (and indeed did) justify monetary easing by saying that it was not only good for Wall Street, but Main Street too, helping to spur demand and job creation. If high consumer price inflation remains a feature of the US economy through the second half of this year, the interests of markets and the real economy will not be so closely aligned.
We’re at a loss to how to position for a shift this momentous. If you’ve any suggestions for what to buy, stick them below. (Not bitcoin please. Or gold.)