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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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Time's almost up for Janet Yellen ...... and the markets will miss her. ref :- "Rockier year expected after Yellen's steady hand " , Analysis / Capital Markets, the Financial Times

December 15, 2017

 

 

Janet Yellen's term of office as Chairman of the Federal Reserve doesn't end until early February, but since Wednesday was her final post-FOMC press conference some sense of an era coming to a close was inevitable. Not that she would have sought to make her appearance seem in any way valedictory ..... everything about her suggests that she's not the sort of person to seek attention, and not the sort of Fed chairman to let her personal profile get in the way of getting on with the job. That of course must be sensible for someone in her position, and something that can't necessarily be said about all her predecessors.

 

Paul Volcker was appointed by Pres. Jimmy Carter in 1979 and inherited an inflation rate that would peak at 14.8% the following year (you see kids, it's true .... this kind of thing really can happen!) . Mr Volcker won the battle against inflation but in doing so he pushed the Fed Funds rate up to 20% (and prime rates up to 21.5%), which ultimately brought on a recession and big rises in unemployment. Furthermore, that recession combined with Ronald Reagan's post-1983 fiscally expansive policies that included large tax-cuts to send the budget deficit through the roof.

 

Supporters of Mr Volcker (and there are plenty) contend that he was tasked with a very difficult job that would have been impossible to bring off without some inevitably painful consequences, whilst the blame for the budget deficit lay with Reagan's fiscally "irresposible" tax-cuts rather than with Fed policy. His detractors, including those in areas such as construction and farming who were suffering from the recession and resulting unemployment, were not inclined to be so understanding. Whatever your view, the point is that the Fed and its chairman had never before been the target of so much vilification and its monetary policies led to accusations that it had become "politicised". That, to put it mildly, could never be described as a good thing for an independent central bank.

 

Ironically enough Volcker's successor , Alan Greenspan, was initially viewed as a quieter sort of character  --  ironic when you consider how his personality came to influence financial markets. Credited with successfully righting the ship after the 1987 crash, his subsequent shaping of monetary policy to support asset prices endeared him to markets and earned him a reputation as a market guru. The so-called "Greenspan Put" referred to investors belief that if things started to turn a bit nasty, the Fed chairman could be relied upon to apply policy to bail them out of trouble.

 

It's obvious in hindsight of course, but that kind of practice just builds up trouble in store. It's another irony that the man so famous for warning about "irrational exuberance"  --  a remarkably direct phrase from someone considered a genius in obfuscation, or "Greenspeak"  --  is blamed for more than one instance of sky-high asset valuations and subsequent crashes. His reputation took quite a beating, and for many he illustrates the dangers of having a "personality" at the top of the Fed.

 

Nobody would ever accuse Ms Yellen of fostering a personality cult  --  her's is a rather grey, somewhat bookish approach to the job and based on the evidence, a very successful one. Consider : under her leadership the Fed has raised rates five times, including three times in 2017 which is more than the market thought likely. She has also instigated the start of the long and enormous task of reducing the Fed's balance sheet accumulated through the bond-purchasing Quantitative Easing process. And yet the markets have remained completely unruffled, soothed by Ms Yellen's deft communication of policy. The economy boasts solid growth , the stock market has risen by 50% since her tenure began in 2014, and bond yields have remained steady  --  much to many people's surprise but aided by the mysterious lack of inflation pressure.

 

The FT ponders whether the next man in line for the job, Jay Powell, will have a harder time of it. The markets seem to have already taken the projections of the Yellen "regime" for three rate rises next year in their stride, and were probably relieved that she didn't bring up the possibility of a fourth. That doesn't mean it won't happen though, and if it does Mr Powell will be the one trying to soothe the markets.

 

One reason why the Fed's current expectations may change is the changing make-up of the Fed's Open Market Committee who make monetary policy decisions. Just about the two most "dovish" of those voting on the committee, Neel Kashkari of the Minneapolis Fed and Charles Evans of Chicago  --  who were the two that voted against Wednesday's hike  --  will be replaced by Loretta Mester of Cleveland and John Williams of San Francisco. Both are markedly more hawkish that the outgoing pair.

 

The Fed may not have altered their view of three hikes in 2018, but they did mark up their projections for growth and employment which presumably means the possibility of another hike is at least a little stronger. The Fed is plainly of the opinion that the effect on growth of the tax package put together by the Trump administration will be comparatively minimal  --  say 0.2 / 0.3%. That won't please the President  --  and what if he's right and the boost is stronger ?

 

Incidentally, there's another consideration that needs to be brought into the equation when we think about the tax plan. Namely, is this really the time to be bringing in tax cuts ? It would seem to be a more appropriate measure to start an economy on an upward cycle, not something to throw into the mix after a long period of growth and asset appreciation. On the political front, it opens Mr Trump up to accusations that he is pandering to the wealthy rather than the middle class, as he claims. More importantly for this conversation, it increases the chances of an overheating economy and further asset bubbles  --  things that can only increase upward pressure on rates.

 

And if you needed another reason why the Fed may be forced down the route of more aggressive policy, think "Financial Conditions" . Rates may have been on the up, but financial conditions  --  which also take into account currency moves, stock markets, bond yields and volatility  --  are actually easier. Some are of the view that the Fed will have get tough a lot faster than most people think.

 

Talking of which,  market prices imply just a 20% chance of three hikes in 2018 never mind four, and the potential for nasty shocks is obvious. Mr Powell has got some big shoes to fill, and quite possibly a much trickier environment in which to do it.

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