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What many think but dare not say: US Fed Chair Powell should resign

Publication Date: 03 Apr 2019 - By Gio Danisi By Gio Danisi
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Investment Strategies Macro Equity USA

It is worth considering the following points:

• The US Federal Reserve's policy of rising interest rates was wrong. In fact, it’s being radically changed. 
• They showed worrisome lack of understanding of the main drivers of the macroeconomy, monetary rules and implications.
• The senseless and drastic change in course in the Fed’s policy cannot be implemented without them taking responsibility for their serious errors and their consequent failure.
• The credibility of the independence of this important institution is deeply compromised, as President Donald Trump keeps on heavily influencing its decisions.
 

There is probably only one way to break this impasse: the resignation of the Fed’s chairman Jerome Powell. 

About six months ago, despite the nearly unanimous opinion of the international economic community, a contrarian viewpoint was that a change in US monetary policy was likely to happen in the medium term. That's because it was worth underlining the following points:

  1. The unemployment rate was not as low as it looked at first sight.
  2. The inflation was not worrisome.
  3. The tightening policy would have boosted the dollar exchange rate, heavily counterbalancing US political and economic targets.
  4. The Fed’s policy would have caused a senseless flattening of the yields curve.

The last two points probably caused the Fed’s decision to stop raising interest rates for one or two years and to stop reducing the size of its balance sheet. In fact, the conflict between monetary and presidential policy pushed Trump to exercise a strong moral suasion on the board of the US Central Bank. Moreover, after the flattening of the yield curve towards the end of 2018, a major equity sell-off occurred, re-igniting criticism that echoed the American President’s.

To make matters worse, Trump still keeps on influencing Fed’s members with public outbursts. More importantly, he is now trying to fill the empty seats of the Fed’s Board with some of his most reliable supporters, undermining the credibility of the institution and, specifically, of its chairman Jerome Powell. Regardless of the different political and economic opinions, these moves appear a clear attempt to put the Fed under presidential surveillance.  

The Fed does a 180 

In the end, simple logic wins: it is senseless to raise interest rates when the long-term inflation perspectives remain unchanged. It will eventually cause an inversion in the yield curve, which will then almost certainly bring a market turmoil, given that most trades nowadays are managed by algorithms set to sell when the curve is flattening.  

Please note that, speaking in general terms, the alleged predictive value of a flat yield curve cannot be applied here, since, in this case, it was caused by human errors rather than real macroeconomic reasons.

Yet again, we often hear that a flat yield curve almost certainly forecasts a recession. That’s besides the point and purpose of this article, but still, it is worth asking doom and gloom preachers: in the past, how often was the average yield at less than 2.5% when the curve inverted?

The truth is that the inflation is not worrisome because we are still living in a deflationary contest. Rates are zero in Europe, UK and Japan and, if this situation persists, the US will continue to buy low cost products (on a dollar basis) from all the countries in the world and import deflation.

The US dollar is strong, but it is yet remarkably cheap if we compare the deltas among the other foreign bond yields.

This will impact unemployment rates, which are not that easy to understand. 

It is worth focusing your attention on the employment level, which shows no particular strength in America at the moment.

All in all, a stronger dollar would undermine the foundation of the American growth as well as the employment rate. Moreover, the US commercial deficit could expand at a faster pace and fiscal deficit would be much harder to finance, as rates went up. At last, the Fed took all the previously mentioned points into account, realised that its policy was misplaced and made the significant decision to change course.

In its chairman’s words:

“We don’t see data coming in that suggest that we should move in either direction. They suggest that we should remain patient and let the situation clarify itself over time”.

They decided to slow down the pace of its balance sheet reduction too, which means selling less securities to the market in the months to come.

Yet, things are not that simple. Economic development depends in part on the actions of the Central Bank. When it decided to raise rates four times in a year, an impact on the economy was to be expected. And its decision to abruptly stop raising rates sounded like a slam on the brakes, in a last desperate attempt to regain control of its vehicle.

Or maybe they were just influenced by politicians or financial market operators.

Either way, the reputation of the institution itself turned out to be seriously damaged. Trump’s recent public moves and statements, previously mentioned here, were the classic icing on the cake of a situation that could easily become toxic.

Future developments 

Currently, it clearly looks like we could expect anything from the future FOMC meetings. The Fed has already shown that it no longer has a strategy. Therefore, all sorts of outcomes are on the table, included, lo and behold, interest rate cuts. Of course, all the decisions will be result of macro- or micro-economic reasons, but no one can exclude that the moves which are to be announced from now on must be first approved by the American President. 

Yet, the opposite is also possible. The Fed could decide to act against the current administration’s position, just to assert its independence, regardless of the necessary valuations about general economic conditions.

In order to stop this dangerous path, which could have long and unpleasant consequences on the markets as well as US growth (and prestige of course!), some options can be surely implemented. Yet, all of them include a formal resignation of the Fed’s chairman Jerome Powell. Regardless of his responsibilities over this situation or his skills and professional reputation, this move may be necessary to start a process that would gradually make the US Central Bank regain its independence and credibility.

In any case, those investors who are currently betting on a future depreciation of US medium-term and long-term bonds, should seriously consider the possible outcomes outlined in this article.

Disclosure:

I have no positions in any of the securities referenced in the contribution

I do not use any non-public, material information in this contribution

To the best of my knowledge, the views expressed in this contribution comply with UK law

I agree with the terms and conditions of ReachX

This contribution is for informational purpose and does not constitute investment advice nor is it an offer to sell or buy, nor is it a recommendation for any security.

Gio Danisi

 

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