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US rate hint pleases markets

John Redwood, Charles Stanley’s Chief Global Economist, looks at this week’s comments by Federal Reserve Chair Jay Powell.

by
John Redwood

in Features

30.11.2018

This week saw sharp gyrations on stock markets around the important speech by the Chairman of the Fed. Jerome Powell signalled by a modest change in his language that maybe the US is near the level of interest rates needed to control inflation and regulate the economy for the future. The Fed had been guiding markets to expect another rate rise this year and three next, but now the suggestion is it might only be one in 2019. US markets rallied strongly on this hint, underlining that the recent sell off has had a lot to do with worries that the Fed will overdo the monetary toughening and slow the economy too much.

Recent Fed policy has led to lower rates of money growth as rate rises have added to the impact of gradually reducing the size of the Fed's balance sheet as quantitative easing becomes quantitative tightening. This in turn has depressed investor enthusiasm and placed some restrictions on new credit to keep the economy and markets moving forwards. Markets are often very sensitive to rates of change, taking a negative view of any lower growth rate.

The US economy has seen fast growth in the most recent quarter, but there is a general view that this will be the peak growth rate for a bit. Car sales have been slowing for some time, and there is some slowdown in parts of the residential property market as well. With mortgage interest rates around 4.8% there is some reluctance to take on new commitments. If people think rates are rising, and variable rate mortgages will go up more, it acts as a dampener on transactions. If the outlook changes and people think they are somewhere near the top of the interest rate cycle for the time being these negative forces abate.

There was also an immediate impact on the dollar, which went a little softer as markets adjusted their view of how much extra interest you might earn by holding dollars rather than euro or pounds. Meanwhile, the oil price has slipped lower despite the imposition of sanctions against Iranian supplies, reducing some of the upward force on inflation indices. Generally, there is continuing downward pressure on retail prices from intense internet competition for retail spend, and considerable downward pressure on various manufactured products owing to plenty of worldwide capacity. There been a bit of an increase in wage growth, but nothing yet to alarm those forecasting future inflation.

The UK media debate remains dominated by domestic politics, yet UK markets behaved rather like other advanced country markets moving in relation to world news on US rates and the world trade issues that overlay the present G20 summit. The biggest threat to world share markets is too much monetary tightening in the main countries and economic areas, followed by possible mishandling of the Italian budget crisis within the Eurozone. Some rapprochement between President Trump and President Xi of China at the G20 would be a bonus for share markets, who would regard an agreement by the US to delay further tariffs in order to have more detailed trade talks as an improvement on the current position.

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