Commentary on Political Economy

Friday 11 June 2021



Fed all about Wall St as inflation gets going

US Federal Reserve chairman Jerome Powell. Picture: AFP
US Federal Reserve chairman Jerome Powell. Picture: AFP
  • 45 minutes ago 

Uh-oh, the Fed – the US Federal Reserve board – might find itself having to confront the challenge of surging inflation somewhat earlier than it thought: like two years earlier; like right now.

This poses two very big issues for us that we were not anticipating – hoping? – having to confront anytime soon and preferably also not for another two years. But if there’s “surprising” inflation in the US, will we get the same “surprise” here? The most immediately potent issue is indirect.

What the Fed does with its policy rate and bond yields and liquidity is the fundamental driver of Wall Street; and what happens on Wall Street drives our market; as we first learnt most pointedly, and painfully, on that one day in October 1987, and have been all too aware of every single day since.

Were the Fed to edge its policy rate higher Wall Street would fall; were the Fed to raise its rate sharply Wall Street would plunge; and of course, simply and irresistibly, our market would follow.

Now, again of course, the Fed is not going to do any such thing.

It meets midweek and it will tell us – and in particular, those smartest, and greediest, guys in all the Wall Street rooms – it will most assuredly not be snatching away the proverbial punchbowl anytime soon.

That rising inflation – on one assessment, hitting 8 per cent annualised through the June quarter? All a mirage, nothing to see here, move on; it’s all driven by “temporary factors”.

That’s essentially what happened on Wall Street overnight Thursday after the latest – “higher than expected” – US inflation figures surfaced. The market initially went down and then recovered; the S&P hit an all-time high.

It was almost as if investors and the Fed were engaged in a highly stylised minuet.

Investors were “saying” first; this is just the merest hint of what will happen if you, the Fed, think even just vaguely of even just slightly firming the loosest money in world history.

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Followed by, yes, we know you are terrified of a market collapse; so just to show we are “confident” you will keep the punchbowl overflowing with 150-proof monetary hooch, we’ll buy the market up.

So, everlasting happy days were re-established: the “market had spoken”, the Fed had been “instructed” to pre-emptively buckle. Most likely it will, in next week’s statement; and if it doesn’t, we’ll see a short, sharp plunge on Wall Street to bring it back to its main game.

Ever since the mid-1990s, when the legendary – in his own mind and the “minds” of his acolytes – Fed head Alan Greenspan uttered those unfortunate two words, “irrational exuberance”, the Fed under every chairman starting with him has contrived to convince itself that its main game is supporting Wall Street.

The Federal Reserve building in Washington, DC. Picture: AFP
The Federal Reserve building in Washington, DC. Picture: AFP

It’s utterly unknowingly convinced itself that the rich, the very rich and the ultra-rich must keep getting richer, so that some will trickle down to the other 300 million Americans.

The problem is that every time the monetary hooch has been up-strengthened – first it was 75-proof, then during and after the GFC it was upped to 100-proof, and now since the pandemic it’s been 150-proof – it becomes potently unstable and more ultimately unsustainable.

In short, will the Fed’s refusal to face the reality of significant inflation in the US set us all up for a bigger reckoning?

This feeds into the second big issue all this poses for us: the Fed and our Reserve Bank have separately embarked on parallel monetary paths, both terminating, so to speak, in late 2023 feeding into 2024.

Both have committed to keeping their policy rate at the same all-but-zero 0.1 per cent. The Fed’s is actually 0-0.25 per cent, which it shorthands as 0.1 per cent.

They both do so on the same analytical assessment that the separate economies need sustained stimulus to lift inflation to their respective policy targets – the Fed’s is 2 per cent, the RBA’s is 2-3 per cent.

And that they both will only get there if the jobless rate falls significantly – in the US to below 3.5 per cent, in Australia to below 4.5 per cent; at which point in each case wages will accelerate and then also inflation. And then rates will be – very gently – edged higher. The idea that this will be this neat, controlled process of modestly rising wages as aggregate unemployment tracks inexorably lower – in the context of this utterly excessive stimulus, feeding ever crazier asset prices – sits somewhere between “optimistic” and utterly delusional.

Then we get the US inflation numbers we saw on Thursday. Headline inflation for the 12 months was 5 per cent; for the last three months alone it added 2 per cent – that’s 8 per cent annualised.

The trouble was, any way you tried to analytically cut the numbers, they kept coming up “awkwardly” high.

Take out those pesky energy and food prices that can leap about – and which central bankers seem to think don’t actually cost consumers – to get the “preferred” analytical number? Well, that was still 3.8 per cent for the 12 months and 1.9 per cent for the last three months – still close to 8 per cent annualised.

In any “normal” world – that’s to say, the world before the GFC led central bankers to believe they could play god with free money – an inflation rate of 5 per cent, far less 8 per cent, would have been utterly incompatible with a policy rate of 0.1 per cent.

In that normal world, the policy rate would have already been at, say, 2 per cent minimum and the Fed would be calling a series of moves higher.

Now, the market crunch aside, a Fed that actually woke and embraced its core responsibilities would not necessarily destabilise the RBA; it would not have to automatically follow; an Aussie dollar drifting lower would be welcomed.

But the idea that we can get to 2024 by the RBA’s path has been instantly rendered fantasy.

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