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I let Marc Chandler stand in for me on the Fed statement last week. But now that the Fed has rescinded its 2019 rate hike guidance, there’s been a lot of chatter about a so-called Fed Put. The prevailing narrative is that Jerome Powell caved when markets melted down, supplying the same sort of backstop that the Fed has supplied to asset markets ever since Alan Greenspan took the Fed’s helm over 30 years ago. I don’t think that’s what’s happening and I will explain why below.
The weakening global economic backdrop
What has the Fed spooked is the simultaneous deceleration of multiple large economies like Japan, Germany, Italy and China. And this is only compounded by the recent market volatility, which is in reaction to that weakness. Think of 2019 as more akin to 2016 when the Fed was prepared to begin a whole train of rate hikes, only to realize that the US economy had weakened considerably due to the shale oil bust.
Here are some of the statistics:
- Recently, Germany’s retail sales slumped at the fastest rate in 11 years (Reuters)
- In fact, Germany may be flirting with recession (Gavyn Davies, FT)
- Italy is in recession after two consecutive quarters of contracting GDP
- In truth, business growth has all but stalled in Europe early in 2019 (Reuters)
- In China, growth is the slowest in 28 years (Reuters)
- And Chinese consumption is getting hit, with car sales in China falling outright for the first time in 20 years (Toronto Star)
- China’s bad debt disposals are at 20 year highs (FT)
- And China’s best performing stock in 2019, Wintime Energy, recently defaulted (SCMP)
- As credit growth shrivels, mainland Chinese banks are now desperate for capital (SCMP)
I could go on.
The point is the US is a relatively good performer in a sea of weakening economies. And the Fed, as the central bank of the world’s reserve currency, has to play a special role in making sure global dollar liquidity doesn’t dry up due its tightening of policy.
The Fed Put
So, this is about the global economy, not US markets. In fact, US markets have recovered strongly in 2019. Stock prices are up, oil prices are up, Treasury bond yields have risen, the Treasury curve has steepened and corporate bond spreads have tightened, showing a considerable easing in financial conditions.
If you hear someone bloviating about the “Fed Put”, claiming that Jerome Powell as no different than Yellen, Bernanke or Greenspan, you will know that they have strong priors. They are pre-conditioned to hate the Fed. And they are letting that bias seep into their analysis.
The US economy’s resilience
I have been relatively upbeat about the US economy for the past couple of years. It has shown itself to be very resilient. And it is one of the best performers in the advanced world, certainly better than Europe or Japan. Nevertheless, not only should the Fed be concerned about foreign economies, there is an ongoing slowdown in growth in the US as well. And the question is whether that slowdown could produce a recession down the line.
I asked several days ago whether a slowing China could tip the US into recession. My conclusion was that:
The US, as a large continental economy, where trade is a lower component of GDP, is in a better position to weather the global growth slowdown. But the risks are mounting. And if the US does fall prey to the Chinese-led global slowdown, it will be the corporate sector that creates the most problems. I am not predicting a US recession any time soon. But, this is no longer an outlier scenario for 2019.
And for me, this justifies the Fed’s reaction in halting its rate hike train. First, they want to see how hikes they have already made impact the economy since monetary policy acts with a lag. The slowdown we are seeing now is arguably the result of past Fed policy. And given that it is having a measurable impact, it makes sense for the Fed to want to pause and see how much the economy slows.
Avoiding an emerging market crisis
Second, the Fed will want to see how the global economy develops. If the weakening abroad continues, it will mean foreign central banks will take more dovish policy stances. And for fear of creating a liquidity crisis via the dollar’s funding role, the Fed will need to take this into account in setting policy. A marked divergence in policy between the Fed and other central banks not only makes borrowing in eurodollars more expensive for foreign debtors via the rate differential, it also puts upward pressure on the dollar, exposing foreign debtors to currency risks as well. The dollar’s climb down from recent highs is due to the Fed’s policy relaxation. And were the Fed to turn more hawkish, the dollar would climb again.
I have been slow to post in recent days due to my schedule and the lack of actionable economic data as the US government was shutdown. But, in the coming days I will be posting a lot more, particularly market-oriented posts for gold-level members.