A few weeks of falling stock prices can make a big difference in the country of central banks. On Wednesday, October 3, Fed chairman Jerome Powell said in an interview that the bank's very accommodative monetary policy is no longer necessary.
The American economy was doing more than excellently at that time. The Fed was therefore busy raising the interest and would continue to do so for some time. “This is because interest rates are currently far away from the neutral level,” Powell reported.
Long way to go
This is the level at which the Fed neither stimulates nor slows down the economy. The Washington central bank says this level is around 3%. When the Fed chairman spoke, interest rates were at 2,25%. In short, there was still a long way to go. The couch continues to raise interest rates; This will be increased in December 2018 and 2019 times in 3. It is true that this is above the neutral level, because the Fed deliberately wanted to raise interest rates slightly above that level (to slow down the economy slightly).
In recent weeks I have repeatedly said that the Fed's rate plans (3 rate hikes in 2019 and 1 in 2020) are based on a very rosy macroeconomic scenario. So those plans won't come to fruition, I regularly stated. On Wednesday evening, November 28 (Dutch time), Jerome Powell was on the stage at the Economics Club. According to the CEO, the official interest rate was just below the neutral level.
In just a few weeks, interest rates (which stood at 2,25% in October and yesterday) went from 'far from the neutral level' to 'just below the neutral level.' That's a U-turn I've rarely seen in the past 20 years. Fortunately, the explanation is easy to find.
Change interest rate
In September this year, the Fed boss said that the Fed would change its course in the event of "a significant and prolonged correction in financial markets." He added that one of the most important lessons from the financial crisis is that the stability of the system is important. My translation of that was: "When we start to fear financial instability, we take immediate action."
Central bank intervention means fewer interest rate increases or decreases. Speaking of U-turns: this was also one. In one of his first public appearances (after being appointed Fed chairman), Powell strongly hinted that he would not come to the aid of the financial markets if the stock prices would decline.
Falling stock prices
The day after his words, stock prices began to fall in the United States, among others, with the result that we are dealing with a decline that we can safely describe as 'significant'. In week 48, the bank published its very first Financial Stability Report. It can be read that if there is a sharp fall in share prices, companies can get into trouble. With all the consequences that this entails for the good prospects for the American economy in 2019.
The report also states: “Even if planned rate hikes are expected and therefore not a surprise to the public, prices could suddenly adjust to higher rates, which could increase volatility in the US and international markets and lead to corporate tensions. " Loosely translated: "As a central banker you can talk like Brugman, but that is no guarantee that the change will be processed smoothly and without shocks on the markets."
Will the ECB respond?
Just as I expected, the drop in stock prices forced the Fed to make a U-turn. When Powell says that the interest rate of 2,25% is just below the neutral level, he is in fact saying that after the increase in December, at most 2 more increases can be expected in 2019. Those 3 increases in 2019 and 1 increase in 2020 seem more science fiction, than something you could even remotely classify as realistic.
That in turn could prompt the ECB to keep official interest rates at 0% for longer than expected or even extend the purchase of government bonds. The bank's most recent plans in this area are to discontinue it as of December 31 of this year.