By Michael O’Neill
Fed Chair Jerome Powell is a happy camper. He said as much in his post-FOMC press conference on March 17. ” We feel that monetary policy is in a good place.” He justified his view saying: a) “(its) well understood by markets,” b) we’ve also taken strong measures to support the flow of credit in the economy, c) we’re continuing asset (purchases) in coming months at a relatively high level.
His comments are a tacit endorsement to even higher stock prices. The Dow Jones Industrial Average (DJIA) has risen 56.0% since March 17, 2020. Mr Powell hasn’t even batted an eyelash.
Twenty five years ago, on December 5, 1996, then-Fed Chair Alan Greenspan said that “irrational exuberance” in the stock market was a cause for concern. He was fretting because the DJIA had risen 58% in twenty-three months. His comments sent stocks tumbling the next day (Friday) but most of the losses were recouped the following Monday.
Obviously, Mr Powell has learned a lesson and is happy just to comment about inflation and employment levels.
Speaking of inflation, there isn’t any, or at least any that matters to the Fed. Mr Powell said, “inflation has fallen well below our symmetric 2 percent objective,” blaming “weak demand in sectors most affected by the pandemic.”
But then he fell on his sword. Well not quite-not even close, but he did admit that the Fed’s inflation management performance was somewhat lacking. His words were ” I think we have to be humble about our ability to move inflation up.”
That explains why the Fed moved from a hard 2.0% inflation target to a loosey-goosey “average inflation rate around 2%” target which a cynic may suggest gives them more freedom to keep interest rates low.
Inflation targeting is only half of the Fed’s dual mandate. The other half is to achieve maximum sustainable employment which the FOMC estimates is 4.1%. That is also a fluid number which the Chicago Federal Reserve says:
“involves many nonmonetary factors that affect the structure and dynamics of the labor market and these may change over time and may not be measurable directly.” Accordingly, specifying an explicit goal for employment is not appropriate. Instead, the Committee’s decisions must be informed by a wide range of labor market indicators.”
In other words, the number is a moving target, implying it can be manipulated to fit the Fed’s message.
The latest Fed message is that US interest rates are not going anywhere, at least until 2023.
Bond traders are pushing back against that view. They fear the inflationary impact of the $2.3 trillion in combined US stimulus programs since December will force the Fed to raise rates sooner and faster.
They may be right about inflation rising, but the Fed is not concerned. Mr Powell repeatedly says we are not even thinking about raising rates.”
If the Fed is going to sit on the sidelines, the Bank of Canada is sure to keep them company.
The BoC monetary policy statement states quite clearly “We remain committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. In the Bank’s January projection, this does not happen until into 2023.”
Some analysts and traders dispute this view. They are even pricing in a small chance of a rate hike in Q4 of 2022. They believe a robust post-pandemic economic recovery combined with higher oil prices will ignite inflation. They claim the evidence is in the data, pointing to the 9.6% Q4 GDP growth rate, the 0.6% m/m increase in inflation, and the 259,000 new jobs added in February.
That view contributed to the Canadian dollar blasting above the 80.00 US cent level to 80.86 on March 18 even though it was unable to sustain the gains.
There are many reasons to be buying Canadian dollars, but the prospect for higher interest rates isn’t one.
A key reason is debt servicing costs. The federal government deficit was projected at $385 billion in November, well before the latest COVID-19 outbreak occurred. It isn’t a stretch to guess it is approaching $500 billion. It could even be higher, which may explain why Canada is the only G-7 nation that hasn’t produced a budget in two-years. Canada can easily manage debt servicing costs at current levels and according to CIBC economists, “Canada is likely to exit the pandemic with a debt-service ratio lower than many of its peers had entering the crisis.”
The low-interest-rate-forever party is in full-swing. The Dow (Powell?) Jones Industrial Average is hogging the dance floor as its euphoric rise has the bond vigilantes saying the Central banks are behind the curve.
Party hosts, Jay Powell and Tiff Macklem are behind the bar serving “monetary policy inertia” cocktails and promising to keep them coming well-past closing time.