Some commentators might even have felt some sympathy for Fed Chief Powell in his first testimony before Congress. He is so obviously navigating a treacherous monetary path ahead without any reliable compass. That is no different from the reality of his predecessor’s position, but at least in Mr. Powell’s case, there is not the academic triumphalism; rather the big danger evident is institutional complacency.
Yet on second thought, why sympathy? That doesn’t seem the right reaction to Washington power politics and a road to the top job which demanded “an excellent relationship with Treasury Secretary Mnuchin.”
Powell's Optimism
The market-moving comment in Tuesday’s testimony (February 27) to the House Financial Services Committee came in the question–and-answer session: Chief Powell hinted that the “dot plots” to be published next month might well shift to include four tiny rate rises (including March) by year end rather than three. The US dollar jumped, stock and gold prices fell accordingly. The basis of the Chief’s view seems to be optimism that strong growth will continue as boosted by the Trump/Republican tax cuts. Ex-chief Yellen, of course, never credited the tax cuts with such positive effect. And this growth cycle upturn is the culmination (from Mr. Powell and his predecessor’s viewpoint) of their successful and innovative monetary piloting of recent years.
Several of the Representatives’ questions were about the dangers of pre-emptive action to stop inflation rising above target at the cost of halting a nascent acceleration of wage-rates. Chief Powell could have retorted that inflationary monetary policy is not good for wage-earners, even though they may make temporary gains when the economy is red-hot. But even that is dubious in real terms. The reason for historically low gains (if any) in real wage rates over the past decade and more, has to do with real factors and monetary mistakes, not the pursuance of sound monetary policy. In fact, policy has been unsound! Real factors include slow productivity, as the Chief mentioned. Also, there has been the increase in monopoly power across the economy — and not acknowledged by the Chief is the argument that the Fed’s monetary experimentation has held back investment spending, the key driver of productivity growth.
It should be obvious (though not possibly to a long-time and loyal official of the Bernanke/Yellen Fed) that the crash and great recession of 2008/9, itself the consequence of earlier Fed monetary mistakes, has had a lot to do with the disappointing level of investment cumulatively since. And even more importantly, the policies of interest rate manipulation, and deliberately generating asset price inflation (and related hunger for yield), have curbed overall capital spending.
Firms can do better for their shareholders (in their opinion) by leveraging up the enterprise — issuing debt at low rates which reflect the manipulation and compressed credit spreads — and retiring equity. This, in their view, is better than undertaking high-stakes long-gestation capital spending (whose dangers have increased with the likelihood of a crash and great recession at the end of this asset inflation). The exception to this is in those areas where there are strong speculative narratives (such as shale oil, big tech, real estate, private equity, sometimes emerging markets). Chief Powell should know all this well from his prior life as a private equity baron. But he did not reveal any such inner thoughts to his non-plussed questioners.
High profit rates now observed stem from a combination of the income squeeze on holders of interest-bearing securities, and the growth of monopoly power in some sectors. Equity investors have loved this combination, even though, from a longer term standpoint, one could ask whether valuations reflect the risks of increased leverage (outside Big Tech) and an eventual Day of Reckoning (for asset inflation). Chief Powell, in response to questions, said that the stock market is an indicator of the economy which he and his Fed colleagues regard seriously; but his institution has no role in determining prices there. Who is he trying to fool? Asset inflations are made in the Fed, Chief Powell, not in Heaven!
Anyhow, Chief Powell is exuding confidence — along with Trump Administration economic officials — about just how strong is the US economy now and in the years ahead. Market participants should know better than to take all this at face value. Fed history is full of big mistakes in cyclical fine-tuning and in perceptions of asset market inflation/deflation dangers. It would not be the first time that a new Fed chief in his opening speeches misjudged the present situation.
What Does the Future Hold?
Up front is the significant probability that the US growth cycle is peaking or has peaked already, with a new growth cycle downturn ahead. That could be the message from the steep reversal of the Chicago Fed National Activity Index (2-month average up at a much reduced pace in January) or the ECRI forward-looking indicators. More broadly, the early February tremor in the stock market and the related widening of credit spreads could all be consistent with that view. And pessimists can point to the probability of unwind in the colossal emerging markets financial boom of the past two years together with growth slowdown in those regions. China is one obvious focus of attention here; but India is a potential grey swan (of several) to consider alongside. The heightened geo-political tensions between China and India across multiple concerns are a source of anxiety.
A surprise US growth cycle downturn together with emerging market cooldown could be positive for the greenback in so far as inflation dangers recede and monetary normalization talk in Europe is seen as even a bigger joke than now widely recognized (together with an increase of credit risks particularly in Europe). Europe is also viewed as highly geared on China and emerging markets (more so than the US). The euro could also reflect rising Russian related geo-political risks.