Judging by the latest speech by representatives of the Federal Reserve, it seems that they are ready to forget about their high-profile goals to destroy unemployment in order to keep prices from a frenzied gallop. Well, it was predictable. However, not everyone inherits the Fed's strategies. Are the leaders of the Bank of Japan so stupid?
Inflation has out the Fed on the shoulder blades... but not the Bank of Japan. The yen's X-factor that no one takes into account
Periods of global monetary policy changes in the American economy are usually dramatic - and not only for Americans, but also for the rest of the world. Those of us who have to follow daily events are now trying to catch the instant reaction of the market. Therefore, it was obvious to experts that the last meeting of the Federal Open Market Committee was unlike any other before, and this is one of the signals.
Indeed, this time the market reacted unusually.
To begin with, the market reaction was quite positive from the point of view of risk assessment – in the sense that the prices of both bonds and stocks rose. That is, experts' forecasts were justified, which in itself pushed the markets to grow briefly.
But this is not the only consequence of the Fed meeting. Now the markets will gradually unfold a consistent picture of the reaction to the new economic conditions for banks and businesses.
In particular, you may have noticed that the main political and economic marker of traders - the yield of benchmark 10-year Treasury debt obligations - declined strongly after the FOMC meeting. Obviously, this is an adequate market reaction to the news, which can not but rejoice in the unpredictability of this year.
Nevertheless, the bonds are still at a level that could hardly have been imagined a couple of weeks ago. A sixfold increase in profitability for the month cannot but be alarming. Yes, the Fed has done enough to stop the continued rapid growth of yields, but is it enough for the economy as a whole?In fact, we are talking about global changes in monetary policy. Six months ago, only two members of the commission said that the federal funds rate would even exceed 1% this year. Now there is complete consensus among them that it will exceed 3%.
At the same time, if you closely follow the Fed's rhetoric, you can see how hastily and, one might even say, convulsively it is changing. If in May we could still read on the official government portal the statement that "with a corresponding tightening of monetary policy, inflation will return to its target level of 2%, and the labor market will remain strong." Now the confidence of Fed Chairman Jerome Powell and his colleagues has finally shaken, so now you can only read about the Committee's intention to return inflation to the target level of 2%. At the same time, the preservation of the labor market is no longer a question.
What should this tell traders about? First of all, that the US government expects a significant reduction in production. So significant that it can lead to impressive job cuts.
Employment is no longer in the Fed's sphere of interest
In fact, the Fed has several levers of influence on the labor market, and of course, even more – to regulate the currency basket.
But it seems that the Fed's employment opportunities are running out. And now the committee needs to reduce its efforts in this direction in order to maintain control over its main direction.
Thus, we can observe that at the moment this is already a done deal: the Fed has deliberately limited itself to the traditional functions of the central bank, whose sole task is to limit inflation.
Probably, under the circumstances, this may be the best way to maximize employment – in the long run, but in the short term it can be painful.
As proof, you can look, for example, at the retail sales data announced a little earlier than the Fed meeting, which showed a decline in May. This is nothing more than the effect of high prices, especially for food and fuel, over which the Fed has the least control, on reducing demand. It's time for the Fed to attack inflation for the sake of a stronger economy and employment in the future.
Another aspect of the FOMC meeting may be of interest to those who are already thinking about the prospects for next year. So, the forecasts for 2023 and 2024 have not changed much. The FOMC still says it will quickly bring inflation under control. And in fact, if we do not see a further escalation of the military conflict in Ukraine, then this is a very real forecast. If.
GDP also has an optimistic outlook. Even if the estimates for this and next year are sharply lower, which again is a direct reaction to the inflation of the last three months. Nevertheless, there is still complete consensus among the committee members that GDP will grow, not fall, in 2022 and 2023, albeit at a slower pace. The official version of the governors is that they still expect a soft landing without a recession. And it can also work, especially within the framework of America. Developing countries will have a much tougher time.
Individual applause deserves a feint with ears, which the members of the committee pulled off with crystal-clear eyes. Having promised the markets to raise rates by 75 basis points, they did not apply such harsh methods, stopping at 50 points of increase. Psychologically, the markets immediately relaxed, taking this as a signal that the economy is not as bad as everyone thought on the eve of the meeting.
As a result, the confidence radiated by Fed officials, along with a soft landing of 50 points instead of a tougher one at 75 points, pushed the markets to optimistic growth. Of the trading sessions that followed the meeting, 75% of the sessions ended in a positive way.
But this is not very good news in the long run.
General results of the Fed meeting
Firstly, such a feint can be turned only once. Because now Powell's promises will be considered an unreliable tool for subsequent assessments of future Fed meetings.
Moreover, this optimism is a purely psychological reaction of the markets, which means that its effect will not last long. And if the next monthly data on inflation, on the level of demand and employment are negative, then this will certainly prove to be a more significant factor, pushing the markets back into pessimism.
This option looks especially realistic in the light of the fact that the conflict in Ukraine is still ongoing, and the summer vacation season begins in America itself. The increased energy costs associated with the use of air conditioners will also not fail to affect the financial condition of households, and offices too, increasing the cost part and forcing savings in other segments.
But even this temporary situation loses in value to the general forecast, which is that the Fed recognizes that it has a problem with inflation. Now the committee is ready to raise rates to eliminate it, even if it means an increase in unemployment. This means that the competition for a good position among applicants will become more fierce. It may also push American manufacturers to attract lower-paid employees from abroad – both remotely and by direct hiring. Americans will definitely be unhappy with this government policy.
What is even more impressive is the willingness and even satisfaction of the market that the central bank is deregulating employment. While the Fed continues to argue that a soft landing is likely (and still close to possible), you can now see for yourself that the playing field has changed.
The people are getting poorer, my Lord
There are still some points that could be taken out of the speech of the Fed representatives after the meeting.
So, if you noticed, Powell continued to insist that many factors of inflation are beyond the control of the Fed.
You can understand it: the price of oil and other goods depends on the situation in Ukraine and measures within China to limit the spread of Covid-19.
However, in fact, we are talking about a more global issue – that the classical school of economics has won once again, and the monetarists, led by Milton Friedman, who considered inflation always and everywhere a monetary phenomenon, were right.Inflation is a direct consequence of the amount of money in circulation. And this is a given that the Fed will now have to face again.
There is much more money around than in the early 2000s, thanks to the desperate fiscal and monetary policies that previously coped with the 2008 crisis, and now have mitigated the pandemic. Although people in general have more money on deposit in the bank in absolute terms, millennials' savings in gold are much lower than those of the boomer generation. It is natural to assume that they will be forced to spend faster, since their savings are an indicator of their standard of living. The less money in the account, the more holes the family has to patch up every day. With this in mind, it is reasonable to assume that more nominal money in circulation and a lower standard of living for Americans will lead to higher inflation. At the same time, in dollars, these may be inexpressive figures. But if you tie them to the gold standard, you will have some unpleasant discoveries in 2023. As a generation, we are poorer than our parents, and this, it seems, is also an immutable fact.
However, let's return to the volume of nominal money.
This volume is almost completely stored on deposits in US commercial banks and is a reliable reflection of the economic situation in chronological unfolding. In fact, this volume has been steadily growing for many years, but then it jumped in the spring of 2020, giving the Fed reason to hope for a "post-pandemic spring."
Perhaps it is a coincidence that inflation remained under control for decades and then jumped (after the lag predicted by Friedman). But it looks very much like these are all interrelated events.
Lessons of 2008
This is one of the decisive factors about where to look for clues in the current situation.If you look at the history of the global crisis in 2008 and the subsequent behavior of the market, you will notice one important pattern: in nominal currency, the markets recovered very quickly. Incredibly fast, if we talk about the effects of the Fed's monetary policy in 2009-2011. But the fact remains.
The stock market classic says: in most cases, stocks are rising. And this rule persists. If there are reasons for panic, it is only for a very short-term panic.
You and I know perfectly well that it's better to buy stocks when their price has just dropped a lot. So you buy them cheaper. And waiting for the bottom can bring a lot of money, but in the long run, the natural tendency of stock prices to rise, in any case, will bring you a good profit. Although we have already said that the markets have not yet reached the bottom, and apparently, this also remains a fair statement.
So this very thesis about the gradual growth of stocks, used by some investors in equally difficult circumstances after the collapse of Lehman in 2008, turned out to be true.
We remember that as of October 1, 2008, Lehman had been bankrupt for two weeks, and Congress objected to the bank's rescue. At that time, the S&P 500 had already fallen by about 25%, and a full-scale bear market like in 1985 seemed imminent. Nevertheless, the Fed's monetary policy was able to push this probability into the indefinite future.
This situation fits perfectly with where we are today.
If you had bought the stock back then, you would have had to endure a loss of over 40% in five terrifying months. This is an undoubted collapse and a huge blow for any investor.
But by the end of 2009, by holding your assets, you would have recovered.
And by the top of the market at the end of 2021, your total profit would be an amazing 440%.
Even in today's market, you would have remained in the black more than four times. And it was in a situation when the American economy was in the deepest crisis – deeper than at any time since the end of World War II.
So why not just keep buying, at least based on the average cost in dollars? – you ask. But not everything is so simple. A lot depends on how much capacity you have.
Of course, this kind of investment with margin is impossible. This is the primary and main reason, for example, that Musk put the brakes on the purchase of Twitter.
There is also a critical argument about monetary policy. Fourteen years ago, the imminent danger was a deflationary recession, and central banks were free to pump up easy money for years. They are about as free as they were two years ago before the outbreak of the pandemic.
This is no longer the case.
But the basis remains the same: stocks usually rise, and stocks are better to buy in the long run when their price has just fallen. At the same time, the bar for exiting the auction should be high.
So is there a bullish case that we missed? I suggest you pay attention to the publication from the strategists of JPMorgan Chase & Co. last week. It was a very optimistic forecast, albeit with amendments to the situation in Ukraine, but experts directly pointed out the possibility of its resolution in the second half of the year. By the end of the year, experts of the world's largest investment bank expect economic recovery.
To be honest, I am skeptical about such statements. Will S&P gain almost 30% by the end of the year? A very unlikely scenario. Of the optimistic factors, only the opening of China looks most likely after two years of the most brutal hunt for everyone who coughed. The first signs of this are there, and there will be more, because it's time for China to pay attention to the economy. In the best case, a wave of fresh liquidity from China will sweep around the world, bringing life-giving coolness to the feverish economy.
But other global problems remain: issues with supply chains need to be resolved, the conflict in Ukraine is not going to subside yet, and even vice versa, and the collapse in the real estate sector will inevitably cause damage.
And overall, global risks remain too high to hope for a bull market.
An additional confirmation of this situation is the currency wars between governments.
Currency basket, currency wars
Governments are more concerned about the exchange rates of their currencies than ever before. So, on Thursday, June 16, the Swiss National Bank shook up the markets, raising the rate by 50 basis points, and then the Bank of England made a hawkish (in the sense that it spurred expectations of more) an increase of only 25 basis points.
As a result, both currencies soared against the dollar, and the Swiss franc, we can say, experienced the best rally against the euro since the Swiss central bank abandoned the attempt to link the currency in early 2015.
Despite this, the pound remains weaker than before the fall in consumer price inflation in the United States last Friday, and the Swiss franc has not yet returned to this month's high.This is abnormal behavior of central banks. In fact, we are facing a struggle for the position of the currency. In this sense, central banks are waging a reverse "currency war", because weakness prevents them from keeping inflation at a low level.
Nevertheless, Switzerland is currently a major global inflationary outsider. Its latest figure was 2.9%, which is the highest since 2008, but still it is almost nothing compared to the levels of the UK (9%) or the US (8.6%).
Bank of Japan
Today, the actions of the leadership of the central bank of Japan can be admired... or perplexed. In any case, no one was surprised that at their last meeting, the yen rate was left at the same level, keeping the target rate at -0.1%. The Bank of Japan, it seems, is now the only central bank that is waging war on traditional currencies in an unconventional way according to the canons of the new economic school – trying to reduce the value of the yen. And this is despite the fact that it departs from his own long precedent and actually the status quo.
It is no wonder that traders also took this statement as confirmation of the main course... and the yen continued to fall. Obviously, the BOJ is going to become a supplier of cheap money to the rest of the world... and this, combined with a fairly strong economy, can be a big trip for the dollar. Is it possible that one day we will wake up in a world in which traders will prefer to link international contracts to the yen rather than the dollar? Who knows, perhaps BOJ Governor Haruhiko Kuroda is an economic genius, whom we underestimate right now.
A weak yen exerts quite serious pressure not only on the dollar, but above all on the Chinese yuan, forcing Chinese politicians to come out of quarantine hibernation faster and more sharply than they would like. The strong growth of the yuan relative to its neighbor has an impact on China's competitiveness. The last time it reached the level of 20 yen, in the summer of 2015, the answer was a sloppy devaluation that caused volatility of currency pairs around the world. Now the yuan is worth 20 yen again – will China feel the need to weaken its currency again? This would create a new furor in the markets.
Despite these factors, you should still understand that such global challenges of the time do not contribute to normal trading in financial markets. Volatility of this magnitude, which has captured even the strongholds of stability in Switzerland and Japan, increases the risk of financial disasters. The BOJ's continued intervention eases conditions for the rest of the world, but also heightens the fear of what could happen if it relinquishes control of the yield curve. Japanese bets will skyrocket, and all those who enjoyed a profitable bet against the yen will empty the pot.
But if that doesn't happen, Kuroda will become his country's next national hero.In any case, inflation is firmly included in the list of must-haves of all central banks in the world. And their actions are not always adequate and appropriate to the time. Of course, they are all focused on maintaining the exchange rate of their currency (and the economy) at any cost... But if everyone succeeds, then who will bear the consequences of two years of quarantine? An indecent amount of money was printed during this period. Many have turned on printing presses. And someone will definitely pay for it. The question is who and to what extent.
