Investors wait to see if Fed blinks under global stress
Powell’s speech at Jackson Hole could indicate circumspection from the US central bank
Michael Mackenzie
Jay Powell, the Federal Reserve chairman, will discuss 'monetary policy in a changing economy' at the gathering of central bankers on Friday © FT montage; Bloomberg
Turkey, Italy and China. Trouble tends to come in threes and such thinking is animating systemic risk concerns among investors, particularly as August has form when it comes to bouts of financial turmoil, as seen in 1998, 2007, 2011 and 2015.
Not surprisingly, investors will be fixated on Jay Powell when the Federal Reserve chairman discusses “monetary policy in a changing economy” on Friday in the idyllic mountain air of Jackson Hole, Wyoming, at the annual gathering of central bankers.
Also watching is President Trump, who told Reuters late on Monday that he was “not thrilled” about the Fed’s decisions this year to raise interest rates.
But thanks to the Trump administration’s injection of fiscal adrenalin via tax reform, the US economy is generating a nice head of steam. Inflation is picking up and running above the Fed’s target of 2 per cent, employment is tightening and retailers such as Walmart and Nordstrom have just announced gangbuster sales growth. That means higher overnight US interest rates, which in turn foster a firmer dollar, only upping the ante for those countries and companies that have borrowed heavily in recent years via the world’s reserve currency.
Hence why the more indebted and foreign capital-dependent countries within emerging markets led by Turkey are enduring a battering. The risk of weaker global growth outside the US has duly dragged key industrial metals prices to the cusp of a bear market. And as China cracks down on shadow financing, the odds of a full-blown trade war loiter with intent. Meanwhile, Italy’s government is preparing a budget that has financial markets on edge, with the Stoxx index of eurozone banks plumbing its lowest level since late 2016.
Not surprisingly, some investors reckon that a circuit breaker beckons in the form of the US central bank blinking. The marked slide in gold since April reflects the shortage of dollars in the global financial system as the Fed tightens.
And as the dollar has rallied further off the back of EM turmoil since the Fed concluded its last meeting at the start of August, Mr Powell’s speech provides a timely opportunity for investors to detect whether rising global market stress may at some stage prompt circumspection from the central bank.
The missing element here, of course, is the absence of US market stress, with the S&P 500 sitting less than 1 per cent from its record high of January, albeit thanks to a pronounced rotation into defensive sectors over the past three months.
Chris Watling at Longview Economics says that while a switch into defensives is often a precursor to a broader market pullback, the strength in the US economy is keeping the Fed on course to tighten policy into 2019.
“The Fed will only pause if the market gives them a reason to do so,” he adds.
While US policy tightening highlights the weak links in global markets and the economy, a key point for investors to recognise is that a smaller balance sheet and a higher overnight rate will provide the Fed with ammunition to deal with any eventual future downturn.
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