For new US Fed chief, easy times demand some tough calls

Incoming US Federal Reserve chief Jerome “Jay” Powell may indeed be the “continuity candidate” that the market assumes, but it’s unclear that more of the same in terms of monetary policy is what is needed right now.
SuZhou Night Recruitment

On Tuesday night, n time, Powell toed the party line in his confirmation hearing with US senators, repeating the consensus positions of the Fed’s board under outgoing boss Janet Yellen: there will be a rate hike in December, a few more next year, and a continued run-down of the central bank’s bloated balance sheet.

Powell will be appointed at what looks like a sweet spot for the global economy, with investors unruffled by the beginning of the end of the post GFC years of monetary stimulus.

The reduction in central bank support programs, in terms of asset purchases, is halfway through, Citi strategists estimate. And “so far, the impact on markets has been limited,” they note. “Perhaps the second half of the taper will bring more market turmoil.”

Perhaps. But the timing of when this “paradigm shift” away from extraordinary support will really kick in remains a mystery. This time last year there was a lot of talk of higher rates and losses in bond markets, which would put expensive asset markets around the world under pressure. Instead it was another fabulous year to make money in at the riskier end of financial markets.

The upbeat mood is nicely captured by the fact that International Monetary Fund forecasters in recent months have for the first time since 2010 begun to upgrade their growth outlook.

All of which, as Macquarie economists put it, means now is the time to “make hay while the sun shines”. The Macquarie view chimes with what looks like an emerging consensus that the turn in the cycle won’t happen until 2019, a year that “is likely to be more dangerous as stronger wages and inflation in the US along with the first rate hike in Europe, collide with further China weakness”.

So what, as the newly ensconced boss of the world’s most important central bank, do you do in this situation? What does “making hay” look like in terms of monetary policy? Ahead of the curve

It seems the incoming crop of top central bankers – Chinese and Japanese central banks are also likely to have new chiefs – will have at least a year of sunshine under which to bask. That should embolden them to try to get “ahead of the curve” – tighten policy in anticipation of rather than in response to climbing inflation. Perhaps they will begin paying more than lip service to the fact that low and even negative yields around the developed world have contributed to what some call “the everything bubble”.

For what it’s worth, the rich countries club, the Organisation for Economic Co-operation and Development, or OECD, has pinned its colours to the mast and said the RBA should preference financial stability over inflation targeting and lift rates now to ward off further risks of a bubble and bust in the housing market.

The RBA is surely not averse to that thinking. In August 2012, former boss Glenn Stevens said he “would have thought that by this point we have to conclude that simply expecting to clean up after the credit boom is not sufficient any more; the mess might be so large that monetary policy ends up not being able to do the job when the time comes”.

If Stevens was saying that five years ago, then what has happened since is a collective failure of nerve under the pressure of almost single-handedly guiding the country through the post-mining investment boom era with only the blunt tool of interest-rate setting. Stevens cut rates eight times over the intervening period, from 3.5 per cent to 1.5 per cent now.

Do central banks have the nerve to “lean” against bubbles now? Do they “make hay while the sun shines” and increase rates to get ahead of the curve, leaving them with enough ammunition to ease rates come the next downturn?

Our central bank seems further from that point than do others, such as the Fed or the Bank of Canada.

The RBA under Philip Lowe – who as far back as 2002 was penning papers on the importance of financial stability concerns in monetary policy making – appears happy with the way regulatory interventions have taken the steam out of the housing market. Lowe also has the (very thin) cushion of rates at a plump 1.5 per cent, which suggests rates could, in a pinch, be cut a couple of times before losing any leverage over the economy.

For central bankers, like politicians, the decisions you make when times are good can sometimes be as important as the ones you make when times are bad.

Incoming US Federal Reserve chief Jerome “Jay” Powell may indeed be the “continuity candidate” that the market assumes, but it’s unclear that more of the same in terms of monetary policy is what is needed right now.
SuZhou Night Recruitment

On Tuesday night, n time, Powell toed the party line in his confirmation hearing with US senators, repeating the consensus positions of the Fed’s board under outgoing boss Janet Yellen: there will be a rate hike in December, a few more next year, and a continued run-down of the central bank’s bloated balance sheet.

Powell will be appointed at what looks like a sweet spot for the global economy, with investors unruffled by the beginning of the end of the post GFC years of monetary stimulus.

The reduction in central bank support programs, in terms of asset purchases, is halfway through, Citi strategists estimate. And “so far, the impact on markets has been limited,” they note. “Perhaps the second half of the taper will bring more market turmoil.”

Perhaps. But the timing of when this “paradigm shift” away from extraordinary support will really kick in remains a mystery. This time last year there was a lot of talk of higher rates and losses in bond markets, which would put expensive asset markets around the world under pressure. Instead it was another fabulous year to make money in at the riskier end of financial markets.

The upbeat mood is nicely captured by the fact that International Monetary Fund forecasters in recent months have for the first time since 2010 begun to upgrade their growth outlook.

All of which, as Macquarie economists put it, means now is the time to “make hay while the sun shines”. The Macquarie view chimes with what looks like an emerging consensus that the turn in the cycle won’t happen until 2019, a year that “is likely to be more dangerous as stronger wages and inflation in the US along with the first rate hike in Europe, collide with further China weakness”.

So what, as the newly ensconced boss of the world’s most important central bank, do you do in this situation? What does “making hay” look like in terms of monetary policy? Ahead of the curve

It seems the incoming crop of top central bankers – Chinese and Japanese central banks are also likely to have new chiefs – will have at least a year of sunshine under which to bask. That should embolden them to try to get “ahead of the curve” – tighten policy in anticipation of rather than in response to climbing inflation. Perhaps they will begin paying more than lip service to the fact that low and even negative yields around the developed world have contributed to what some call “the everything bubble”.

For what it’s worth, the rich countries club, the Organisation for Economic Co-operation and Development, or OECD, has pinned its colours to the mast and said the RBA should preference financial stability over inflation targeting and lift rates now to ward off further risks of a bubble and bust in the housing market.

The RBA is surely not averse to that thinking. In August 2012, former boss Glenn Stevens said he “would have thought that by this point we have to conclude that simply expecting to clean up after the credit boom is not sufficient any more; the mess might be so large that monetary policy ends up not being able to do the job when the time comes”.

If Stevens was saying that five years ago, then what has happened since is a collective failure of nerve under the pressure of almost single-handedly guiding the country through the post-mining investment boom era with only the blunt tool of interest-rate setting. Stevens cut rates eight times over the intervening period, from 3.5 per cent to 1.5 per cent now.

Do central banks have the nerve to “lean” against bubbles now? Do they “make hay while the sun shines” and increase rates to get ahead of the curve, leaving them with enough ammunition to ease rates come the next downturn?

Our central bank seems further from that point than do others, such as the Fed or the Bank of Canada.

The RBA under Philip Lowe – who as far back as 2002 was penning papers on the importance of financial stability concerns in monetary policy making – appears happy with the way regulatory interventions have taken the steam out of the housing market. Lowe also has the (very thin) cushion of rates at a plump 1.5 per cent, which suggests rates could, in a pinch, be cut a couple of times before losing any leverage over the economy.

For central bankers, like politicians, the decisions you make when times are good can sometimes be as important as the ones you make when times are bad.