Central Bank coordination has morphed into co-dependency
In 2008, as the global financial crisis pummeled markets, central banks around the world moved in tandem, taking decisive action to reassure markets that someone was at the helm as much as to stimulate their economies as to repair financial systems.
A decade later, the picture looks eerily similar, yet oh-so different. Investors do expect two major players, the European Central Bank and the Federal Reserve, to ease over the next two weeks. But we’re not in the throes of a major financial crisis, or even a downturn in the U.S., though there are pockets of weakness around the world.
That likely means monetary policymakers aren’t working in considered coordination as much as acknowledging a weary truth: despite the rise of nationalism around the world, our economies and financial systems are now codependent. It’s a reality investors would do well to understand.
Markets widely expect some sort of easing from the ECB when it meets Thursday, and as of Friday afternoon were assigning a 91% likelihood that the Fed will cut interest rates, and possibly announce some additional measures, the following week. With U.S. unemployment near its lowest point in four decades, strong retail spending and markets proving resilient through all the volatility, it may be hard for many investors to understand why.
“The Fed has changed since 2008,” said Kim Forrest, founder and chief investment officer at Bokeh Capital Management. “Because of the 2008 crisis, we have to react to low interest rates. And we have an ungodly high dollar because money comes in here to buy our debt. They understand they have to bring rates down to match the rest of the world. Good luck, Chairman Powell, trying to explain that. It’s a political landmine.”
Global central bankers may accept that they’re yoked together, according to Forrest, but they may not have come to terms with the reality that they’re out of powder. “All the stuff that these central banks are doing can’t affect the real economy because of the underlying trade war,” she said. “That’s artificially suppressing economies.”
In contrast, Steve Blitz, chief U.S. economist for TS Lombard, thinks the Fed, at least, can have an impact on the U.S. economy. While monetary policy actions and reactions aren’t mechanical, he said, we can expect a short-term interest-rate cut to steepen the yield curve – that is, to ensure that shorter rates are considerably lower than longer ones, which is good for the banking sector. A rate cut will also weaken the dollar, which is good for the economy.
“Easing of financial conditions steadies the equity market and keeps employment positive, which keeps incomes positive, and people spend,” Blitz told MarketWatch. Blitz initially forecast a 25-basis point cut for September, but after the August jobs report turned out weaker than expected, he said in a research note, “Remembering the headwinds of negative curve, strong dollar, and weak global growth (all interrelated) and that the Fed’s mantra is to push inflation higher and its only means available is running the labor market ‘hot,’ I think there is a better than even shot of 50-point cut in September – certainly more than what the market is pricing in.”
In an interview, Blitz said that Fed hawks still will need to be convinced that the rest of the world – economic expansion and ultra-low rates – matter to U.S. growth, and he’s skeptical about how readily they’ll embrace that view. But the notion that policymakers are engineering a few surgical “insurance” rate cuts to allow the economic cycle to continue, rather than starting a new easing cycle, “is a lie, whether they want to admit it or not,” he said.
Fed Chair Jerome Powell, speaking at an event in Zurich Friday, was more dovish than many analysts had anticipated, though he gave no hints about his thoughts on specific monetary policy moves.
For Rebecca Felton, chief risk officer for Richmond, Virginia-based RiverFront Investment Group, the key idea is the interconnectedness of world economies. The U.S.-China trade war doesn’t just impact those two countries, she noted, but also their trading partners, such as Japan. She takes the “insurance cut” notion at face value. “Slower growth isn’t necessarily a bad thing,” Felton said. “That can extend this bull market by making it more sustainable.”
Indeed, in a note out Friday, economists at CIBC said the global push toward easing will include Canada, and forecast a 25-basis point cut by the Bank of Canada at some point this year. They also nodded to the benefits of a less-expensive currency: “The export lift from a cheaper loonie will be welcomed, given the limited upside for domestic debt-financed demand, and sluggish growth in major foreign markets.”
U.S. stocks closed out the week higher, even after Friday’s weaker-than-expected jobs report. The Dow Jones Industrial Average DJIA, +0.26% gained 1.5% for the week, while the S&P 500 index SPX, +0.09% and Nasdaq Composite Index COMP, -0.17% both rose 1.8%. The benchmark 10-year Treasury notched its largest one-week yield gain since July 12.
What does it all mean for investors? Perhaps simply that this is the new normal, and that normal times call for steady investing. Felton’s firm recently turned more defensive in portfolios that have shorter time horizons, but that mostly just meant moving money into U.S. securities from the developed international world. “We are still fully-invested, risk-on in our longer horizon portfolios,” she said.
Bokeh Capital’s Forrest thinks the U.S. is the best house in a bad neighborhood. “We tell investors to look at good companies, not market timing,” she said. “We have a relatively strong economy, with patches of weakness. You have to pay attention to areas that are affected by the trade war, such as agriculture. But retail investors shouldn’t spend a whole lot of time forecasting a recession. Look three to five years out.”