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How will the Fed get out of Jackson Hole?

As central bankers assemble in Wyoming for their annual talking shop, the best we can hope for may be no new damage to markets.

As central bankers assemble ion Wyoming for their annual talking shop, the best we can hope for may be no new damage to markets.

by
John Redwood

in Features

20.08.2019

Jerome Powell, Chairman of the Federal Reserve, has a difficult task on Friday when he addresses the annual meeting of central bankers, economists and others in Jackson Hole, Wyoming. The world and its markets will be watching and listening carefully. They will want him to perform two impossible tasks. They want him both to be independent of the US President, and want him to imply or announce further rate cuts and monetary easing. These two tasks are difficult to reconcile.

The Fed has held the view that the US economic data is fine, and there is no great need for monetary loosening. Indeed, at the start of this year they still thought they needed to raise rates and head off a possible future inflation. The president wants lower interest rates, and is peeved that the US has higher rates than the rest of the advanced world. This he sees as underlying a strong dollar, which gets in the way of correcting the US’s large balance of trade deficit.

The markets were probably right at the end of 2018 to signal that the world economy was slowing and needed some stimulus to prevent the manufacturing recession tipping into something bigger and more widespread. They are still right to worry about the pace of growth in the Eurozone, and maybe to want more stimulus in China. It is less clear that the US needs further monetary stimulus. Retail spending continues to grow, there are plenty more jobs, real pay is on the rise and GDP itself is advancing at more than 2% per annum. Money and credit growth has been brisk in recent weeks which included the recent rate cut. Were Mr Powell to stay data-driven he might now say there is no need for further rate cuts. That would doubtless unsettle the markets.

Reassurance repeated

Instead, Mr Powell is likely to repeat his recent mantra that trade uncertainties and the global backdrop argue for some more easing. The worldwide car industry has been badly hit by a variety of forces. These include the general wish to change over from diesel cars to all electric cars in a hurry before consumers are willing to buy electric cars in sufficient numbers, and before the manufacturers have put in enough capacity to effect a major shift in output. The loss of confidence in general manufacturing has reduced investment intentions and has knock on effects on plant and equipment. The advent of substantial tariffs on a wide range of Chinese imports into the US has worried many investors. All the time there is no resolution of the dispute in sight, Mr Powell has a reason to take a more relaxed view of the monetary situation.

The meeting is likely to look forward to some further relaxation in the Eurozone. As Christine Lagarde takes over from Mario Draghi at the European Central Bank there may be further downward tweaks to bank interest rates and a possible resumption of some quantitative easing. The Eurozone economy is slowing too much, with Italy in recession in the second half of last year and Germany now struggling to avoid a recession following a negative second quarter. Japan too may be ready to ease some more. China has modestly devalued her currency whilst vigorously denying she is a currency manipulator, claiming the markets have driven the yuan lower owing to the imposition of tariffs.

Trump looms large

Donald Trump towers over all these issues and discussions. We await the Fed’s rethink on how to settle interest rates, and watch the Chinese response to the many challenges delivered to them by the US. Central to President Trump’s case is the proposition that the Chinese, the Germans and others are devaluing in order to sustain large trade surpluses at the US’s expense. He sees the Fed aiding them by keeping the dollar high by offering relatively very attractive interest rates to the rest of the world. China blames him for the weakness of the Chinese currency, as the world worries about Chinese exports against a background of high and rising tariffs.

The President also seems to like raising large sums from tariffs which gives him greater budget flexibility. He reckons this is not at the expense of the US consumer who appears to pay when they buy the foreign goods. The President thinks China takes the hit, partly by devaluation and partly presumably from squeezed margins as they fight to keep their prices down despite the tariff. He also hedges his bets by not placing tariffs on some highly-sensitive consumer goods US people wish to buy from China, delaying the tariff imposition until 15 December so voters can avoid them by shopping in good time for Christmas.

The best we can hope for from Jackson Hole is no new damage to markets. The Federal Reserve is likely to use Trump’s trade war as a reason to err on the lax side on rates and credit. The other main central banks will be leaning towards more accommodation, as they represent economies where the underlying figures about economic output are slowing, in some cases too much. Meanwhile, in the currency markets countries seem to be keen to encourage falls in the value of their own money as they try to sustain exports against a difficult world trade background.

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