There comes a time when central banks maneuver themselves into a situation where whatever they do or say will not go down well in the markets. I wrote that some time ago. And we may well have reached that point this week.
Jerome Powell, chairman of the US central bank (Fed) spoke at a meeting on economics and monetary policy. Financial markets were eagerly awaiting what the world's supreme central banker was going to say about rising long-term interest rates in the country. The benchmark 10-year rate had climbed to almost 1,5%, up a full percentage point since August last year. That's quite a lot.
Of course, the rise in inflation and the fear of its further increase is also important. But what Powell was going to say about inflation was already known. Anyone who took the time to listen to Powell in recent months knew that the bank welcomes a further rise. Quite nonsense: after all, the policy she has been pursuing since 2007 has exactly that as its goal.
Achieve safe returns
But those rising long-term interest rates were interesting for the markets. Rising interest rates enable investors to achieve higher, safe returns. Which in turn makes the shares less attractive. Especially because there has been quite a bit of uncertainty lately about whether share prices have become too disconnected from any economic reality.
If Powell hinted that rising long-term interest rates were causing sleepless nights at the bank, they fell again and made shares correspondingly more attractive. The Fed boss also had a quite plausible story for such a hint. The US economy is poised to begin a recovery from the 2020 coronavirus recession and low growth in recent months. A significant interest rate increase is the last thing it needs.
Interest rate increase not disturbing
But Powell didn't. He surprised the markets by being quite laconic about it. Powell called the interest rate rise not disturbing, which was immediately taken as a sign that the Fed is not putting any obstacles in the way of further increases. Long-term interest rates continued to rise and stock prices fell sharply. Stock markets don't like surprises.
Suppose, however, that Powell had said that rising interest rates on the American capital market are a source of concern for the Fed. There is a good chance that mild panic had also arisen on the financial markets. After all, if the Fed boss says that a 10-year interest rate of 1,5% nominal (nearly 0% in real terms) will frustrate the recovery of the US economy, what does that say about the state of that economy? Nothing good, methinks.
Markets challenged
What Powell has caused, besides a further rise in yields, is that he has challenged the markets to test the Fed. How far must the 10-year yield rise before the Fed will have sleepless nights and take action? The markets love to play that game.
The Fed's interest rate committee meets on March 17. I am not surprised if damage control is done before its members take their place behind the oval mahogany table in the Fed meeting room. And Powell made a completely different sound in the press conference afterwards than earlier this week. In my view, Powell's laconic behavior regarding developments in the interest rate markets in particular has increased the chance of new interventions by the Fed.
Why doesn't it surprise me? Take us back in time. It is September 2018. When asked what he believes is the most important lesson since the American investment bank Lehmann Brothers collapsed exactly 10 years earlier, Powell said "that the stability of the financial system is important."
Stability at risk
When is the stability of the financial system at risk? In the current environment, this is the case when not only interest rates rise, but also when stock prices fall. Speaking of 2018: the Fed was busy with a series of interest rate increases at the time. When the markets realized that the bank really wanted to continue with this in 2019, share prices crashed.
Powell made a U-turn that I had rarely seen before at a central bank. The planned interest rate increases were canceled and the bank cut the official interest rate. I won't be surprised if the Fed makes another U-turn this month. With, as mentioned, all the associated risks. It's a Catch-22 for the Fed - or better - to align with the Fed rate: it's a Catch 0,0 for the bank.
Since 2007, central banks have virtually used up their normal monetary weapons. The interest rates are often at 0% or not far above and quantitative easing also involves quite a bit of money. In recent years, central banks have therefore created a new instrument for themselves, called forward guidance. Central bankers also explain what their future plans are and under what conditions they will or will not be implemented.
Linguistic monetary instrument
For example, the Fed says it will raise interest rates when maximum employment has been reached in the US (i.e. an unemployment rate of less than 4%) and annual inflation has structurally reached just over 2%. And it will remain there after a change in monetary policy. If indeed we have reached the point where whatever central bankers do or say does not go down well with the markets. Then the obvious conclusion is that the linguistic monetary instrument has now also run out of resources. What now Powell and Co?
I will not be surprised if the answer is: more of the bizarre policies that are being pursued and do not rule out new forms of that policy. This increase in long-term interest rates may simply come to a standstill in the near future and change into a downward phase. The prospect of even looser and longer accommodative monetary policy and falling long-term interest rates could easily push up precious metals prices.