The last SriKonomics discussed how Federal Reserve Chairman Jerome Powell argued, unconvincingly, at his press conference June 14 that the central bank was not done with hiking rates after pausing that day. Given the Chairman’s level of credibility, equity markets rallied on the assumption that the Fed would not pursue the tightening that Powell had suggested.
He found himself left alone at the pausing altar as other major central banks made significant tightening moves, and he was forced last week by these developments to virtually guarantee a rate increase at the next meeting of the Federal Open Market Committee on July 25 - 26. Powell was speaking to House and Senate committees on Wednesday and Thursday in his semi-annual testimony on monetary policy.
The most significant of these global moves was the surprising 50 basis point hike in the policy rate by the Bank of England on Thursday compared with the 25 basis point increase that markets had anticipated. The increase in the rate from 4.50% to 5.00% was in response to inflation continuing at well above the BoE’s target, and followed persistent wage pressures — headwinds that the US economy also shares. The move was an acceleration from the 25 basis point hikes that had been implemented at previous meetings of the Monetary Policy Committee.
In speeding up the pace of tightening, the BoE joined the Bank of Canada and the Reserve Bank of Australia, both of which resumed rate hikes earlier this month after their pause had only prompted inflation to remain elevated. Norwegian and Swiss central banks also continued the tightening process last week.
It is not as if the Fed is dealing with problems more serious than those encountered by the BoE and, therefore, had to pause. The United Kingdom is facing the prospect of recession. Perhaps even more critical, a number of UK homeowners are likely to find their mortgage rates increase substantially in coming months in response to the surge in gilt yields across the curve. The BoE hike came despite a mortgage crisis which is likely to become a huge political and economic challenge for the Conservative government ahead of UK general elections expected next year.
What was Powell’s justification for pausing on rate hikes this month? He provided the analogy of a driver proceeding at 75 miles per hour on the highway, then slowing to 50 miles an hour on a local highway, before slowing further as the individual approached the destination. In other words, he was attempting to portray the pause in hikes that he and his FOMC colleagues implemented on June 14 as an act of caution.
But there is a big difference in what that your analogy would imply for monetary policy, Mr. Chairman! If the driver has no clear idea as to how to get to a location, stopping the car — pausing on rate hikes — will not take the individual there any faster. Just as the driver would have needed a detailed route map before starting to drive, the FOMC ought to proceed only after establishing rules for setting policy rather than employ a seat-of-the-pants approach as is currently done.
As in the previous week when the FOMC decisions were made, the reaction of US equity and fixed income markets to global developments diverged. Equities took a hit as investors realized that even their benevolent Uncle Jay could not save them from further rate hikes given the outlook for tighter monetary policy around the world. The Treasury 2 10 yield curve, which has been inverted since July, became even more so, continuing to signal that a recession is in prospect. The spread between two- and ten-year Treasurys of -101 basis points last night was approaching the peak inversion in this cycle of -108 basis points set on March 8.
Perhaps most important, reality set in the markets and “soft landing” believers suddenly became a scarce commodity. Who said there is no silver lining in every cloud?
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
June 24, 2023
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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