Central bankers are progressively adopting a pro-cyclical behavior. The global growth momentum is now lower and central banks’ strategy now have a restrictive bias. In the US, Canada, UK and in many emerging markets, central banks’ rates are higher than at the beginning of the year. This has already changed expectations and it will continue with a downside risk on the economic activity.
The Fed’s meeting today is an opportunity to show the dramatic monetary policy divergence between the US central bank and the ECB and the risk for a stronger greenback.
The first graph shows the gap between monetary policies’ expectations in the two countries. The measure here is the 2 year rate in 1 year. The time scale begins with the Euro Area inception in 1999.
The divergence between the two central banks’ strategy has never been so important. It’s a strong support for the US dollar which will continue to appreciate and it’s a source of risks for emerging countries. The strong probability of a US tighter monetary policy in a foreseeable future will support capital outflows reducing liquidity on these markets. Continue reading
Discussions on wage dynamics in the Euro Area. The momentum is now higher (2%) but not sufficient to push core inflation on the upside. The enigma is not solved yet. That’s the analysis of this NY Times article.
Nevertheless, the example comparing France and Germany in the article is not totally convincing. There is still a lot to understand on the labor market.
Workers may finally be getting a bigger piece of the economic pie — at least in Europe. Just don’t ask why, or whether it will last.
In the decade since the financial crisis, much of the global economy has recovered and is back on stable footing. Companies are reporting record profits, unemployment levels are plummeting and overall global growth is back on track.
Wages in most developed countries, however, have barely budged.
Read the article here. nyti.ms/2mI1Hnv
Jerome Powell said that the yield curve flattening was not a source of concern and that it wasn’t showing a risk of recession as the economy is following a strong trajectory.
This point of view can be challenged for at least two reasons
1 – A negative yield curve (10 year rate below 2 year rate on government bonds) has always been a signal of recession with a lead of 18 to 24 months. The following graph is clear. Each negative yield curve is followed by a recession with a lag. The current spread is lower than 30 basis points, almost one increase of the fed funds rate.
We expect this yield curve profile for the end of this year due to the tighter monetary policy and therefore we have a strong probability of recession for 2020.
2 – The yield curve flattening reflects higher short term rates and no strong expectations on the long duration side showing that investors do not forecast a bright and strong future.
The tighter monetary policy means that the funding of the economy will be constrained for consumers and companies. We’ve seen recently that companies’ debt (as % of GDP) is at a record high and that consumer credit is still increasing rapidly. The impact of higher short term rates will be negative for both of them.
On the real estate market, around 50% of the financing is coming from brokers whose funding is linked to short term rates. For them too the situation will dramatically changed.
Moreover, an expected tighter monetary policy has provoked higher mortgage rates which will be damaging for households as real wages are no longer creeping up.
The argument saying that “this time is different” must be related to the discussion Reinhardt et Rogoff had in their famous book “This time is different”. Investors always think that the situation, at the moment they live it, is different from what was observed in the past with same type of signal. Reinhardt and Rogoff just say that it is not different on financial markets. An unbalanced situation must be adjusted. Current sources of “this time is different” argument are based on the neutral and non observable long term rate and also on the Fed’s balance sheet operations that have an impact on long bonds through the Fed’s reinvestment of their portfolio proceeds
In other words, the impact of higher short term rates will be negative on the US private sector and could be the source of the expected lower momentum on the economic activity. It it just the impact of a tighter monetary policy as we’ve always seen it in the past. This time is not different.
A discussion of Jay Powell’s speech at the congress can be read in the following FT article
An interesting point of view on the role and the place of central bankers in the political spectrum.
In an interview with ProMarket, former Bank of England deputy governor Sir Paul Tucker explains why the “unelected power” of central bankers threatens our system of government.
Sir Paul Tucker
The European Central Bank found itself under renewed scrutiny this month, after Italy accused it of buying too few Italian sovereign bonds, allegedly in an effort to pressure the country’s new populist government to adopt more conventional economic policies.
The accusation was yet another example of the curious position the ECB has repeatedly found itself in ever since the central bank’s president Mario Draghi promised to “do whatever it takes” to preserve the euro in 2012. But it was also part of a larger, global wave of populist attacks against central banks. In Turkey, President Erdogan has repeatedly attacked the country’s central bank for raising interest rates, even going so far as to threaten the bank’s independence. In Britain, Environment Secretary Michael Gove has assailed the Bank of England and other central banks for their loose monetary policies, arguing that these policies benefited a small minority of “crony capitalists” who had “rigged the system” in their favor.
This political backlash came as no surprise to Sir Paul Tucker, the former deputy governor at the Bank of England and a research fellow at the Harvard Kennedy School of Government. Central bankers, Tucker writes in his timely new book Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State, have emerged from the financial crisis with enormous new powers, entrusted by governments with the ultimate responsibility of making the economic recovery work. This change, he writes, relied on the “false hope” that central banks can create long-term prosperity. It is also fundamentally different than the response to the Great Depression, which was led by elected officials, not central bankers. Their expanded responsibilities, argues Tucker, have also turned central bankers into the “poster boys and girls” of unelected power, a process which ultimately erodes the legitimacy not only of central banks, but also our system of government as a whole.
Tucker, the chair of the Systemic Risk Council, a non-partisan think tank composed of former government officials and financial and legal experts, is a lifelong central banker. His book, an ambitious tome that stretches over 656 dense pages, is both a philosophical treatise on the limits of the administrative state and a passionate call for fellow technocrats to heed the lessons of recent political upheavals, pull back their power, and engage the public in a wider debate.
We recently sat with Tucker, who visited the Stigler Center in May for a series of interrelated lunch seminars, for an interview on politics, regulatory capture, and central banking’s crisis of legitimacy.
Read the interview promarket.org/former-central-banker-tells-central-bankers-stay-away-davos/
The Chinese central bank is loosening its monetary policy to cushion the trade mayhem’s impact. It’s becoming more counter cyclical