This is the most important central bank story of the week so far
Stockmarkets shot up yesterday after the Federal Reserve said it would hold back on raising interest rates. John Stepek looks at what’s behind the change of heart and what it means for your money.
Yesterday, a very important central banker made a statement that had a massive impact on stockmarkets.
We'll get to that in a moment.
In other news, the Bank of England warned that sterling could drop by 25%, house prices could crash by 30%, and interest rates could go as high as 5.5% in the event of a no-deal Brexit.
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Markets know well enough by now to ignore the haverings of Nostradamus Carney over at the BoE.
But the soothing tones of Jerome Powell at the Federal Reserve? That's quite another matter.
Markets finally found the Powell put
Stockmarkets rocketed yesterday. The S&P 500 enjoyed its biggest one-day jump since March, rising by 2.3%. The Dow Jones made it to 2.5%, and the tech-heavy Nasdaq which has suffered the brunt of the recent sell-off gained nearly 3%.
Why? Well, remember earlier this week I was pondering whether Jay Powell (I feel he's been in post long enough now for us to officially shorten his name), would throw the markets a bone?
He did.
Here's a bit of background. At the start of October, Powell freaked markets out by saying that the Fed was a "long way" from a neutral policy. In other words, there was still a while to go before the Federal Funds rate (the key US interest rate) was neither stimulating the economy, nor holding it back.
Markets don't like rising interest rates. It means credit is getting more expensive. You're not borrowing as much growth from tomorrow you need growth today. For "jam tomorrow" stocks and a "jam tomorrow" economy, that's bad news.
We all saw what happened next. Ever since that date, markets have been testing Powell, trying all the time to find out exactly where the "Powell put" is.
(In case you haven't gathered by now, the central bank "put" refers to the expectation that when the market falls far enough, the central banker in charge will calm everyone down by loosening monetary policy, or at least not tightening it as rapidly.)
Well, it looks like they found it. Powell came out and said that rates were now "just below" the neutral level. You could read that in lots of different ways, but with this stuff it's as much about the delivery, as the content.
Previously, Powell has been signalling that he's on course to raise rates no matter what. Now he's giving the market a more forgiving tone he's telling them that he's aware of their concerns, that the Fed is watching the data, and that he's willing to stop if needs be.
Markets now reckon that there will be just one interest rate increase next year, as opposed to the four they expected a few months ago. And thus they leaped higher.
As Michael Purves of Weeden & Co told Bloomberg: "We're talking about getting back into Goldilocks here. Mediocre growth with a friendly Fed."
It looks as though the Santa Claus rally is on
What does this mean for investors? I would think that we're gearing up for the Santa Claus rally to be on.
To be clear, I don't think this should make any odds to your investment strategy. Unless you're a short-term trader then you really shouldn't worry too much about what US stocks are going to do over the next month or so.
And I am still struggling to believe that 2019 is going to be good for markets. I think the key difference between my bearish view and most people's bearish view, is that most are still concerned about deflationary forces and a major slowdown, which I think is a red herring.
Instead, I reckon the risk is that inflation will kick in hard, and then after a possible initial bout of euphoria, investors will realise that the game is up.
But we'll see. In any case, stick with your game plan. Own cash, some gold, and cheap stock markets. For anything more specific than that, read MoneyWeek (you know where to subscribe).
Oh, and on that panic scenario from the Bank of England I just wouldn't fret about it. If you told me to come up with a worst-case scenario for any country in the world, I could go off and find you something to fit the bill. It's not hard to do.
But the idea that the Bank would raise interest rates to 5.5% if the economy was crashing? Not likely. You can go on about protecting the currency, but the last time sterling fell, the Bank slashed interest rates to a 5,000-year low and started printing even more money, thus exacerbating the situation. So I don't buy it.
It is surprising to see the Bank put its neck on the line in this way again though. You can blame us undeniably evil gentlefolk of the press with our scurrilous sensationalising ways. But the Bank is hardly a newcomer to dealing with journalists.
So the thought process at play here baffles me. But like I said earlier with Powell, it's not all about the content it's about the presentation. And I can tell you, if you declare that UK house prices might fall by 30%, you're looking to grab a headline.
What one might expect to gain from doing so is beyond me.
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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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