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Praise be, brothers and sisters!
It took him almost a year to get it. But Federal Reserve boss Jerome Powell has finally turned to the light and embraced the Greenspan gospel.
Commandment number one being: “Thou shalt not allow the S&P 500 to fall by 20% from its most recent high”.
Some of you may be wondering what I’m on about. I’ll explain everything below.
But it’s increasingly looking like the conditions for a “melt-up” are falling into place.
A quick and heavily biased history of monetary policy and moral hazard
OK, let’s have a very, very quick recap of the history of monetary policy since the late 1980s.
Alan Greenspan was Federal Reserve chairman back then, taking the job over just before the 1987 crash. Greenspan is notable for two things.
One: his zen-like ability to believe in the power of free markets, while simultaneously believing in the centralised control of the most powerful force moving those markets, the availability of money.
Two: his complete inability or disinclination to recognise the potential for damaging malfeasance in a cosily regulated financial sector that had come to believe that the central bank stood behind it in all situations.
More than anyone else, Greenspan created the culture of moral hazard which I believe led us to 2008, and continues to lead us to wherever we’re going now.
I could go on for ages along this line, but you don’t come here to hear me rant.
Long story short, every time there was anything that looked remotely like a “crisis”, Greenspan would spring into action, cutting interest rates, flooding the system with money, and bailing out bad actors. It never seemed to occur to him that there might be bigger issues with a financial system that was apparently unable to weather even a relatively mild downturn, without fears that it would cave in on itself.
Greenspan’s constant coddling of the financial sector, and suppression of interest rates, created the US housing bubble and the subprime disaster that went with it. He retired before the big bust happened, and handed the time bomb to his acolyte, Ben Bernanke.
When that bomb went off, Bernanke responded the only way he knew how – by printing lots of money (after getting permission from the US government). And to be fair to Bernanke, it was probably the right short-term response, given just how damaged the financial system was.
But after that, the coddling went on. The US fixed its banks much more quickly than any other country (Europe still hasn’t got there). But it took the Fed, under Bernanke and then Janet Yellen, nearly a decade to end “emergency” monetary policy. Every shift in stance was heavily signalled ahead of time, and if the market looked like it was going to fall as a result, the policy was slowed or reversed.
In effect, the central bank took its instructions from investors, who showed their pleasure or displeasure by sending the US stockmarket higher or lower. Yellen managed to gently usher markets to the point where they were happy with the idea of slightly higher interest rates and the reversal of quantitative easing (money printing).
Yellen, like Greenspan, then handed the job of dealing with that little time bomb over to Jerome Powell at the start of 2018.
The education of Jerome Powell
At first, Powell seemed different. He was a tough guy. Inflation was rising, so was employment, and the economy seemed pretty healthy. What were interest rates doing down there? Why was the Fed’s balance sheet so large when the US was at full employment and the government was splurging on massive tax cuts?
Powell said that rates would rise (they did). And he said that quantitative tightening (QT, the reversal of QE – money burning) would carry on steadily, and that markets shouldn’t worry about it.
But they did. Deprived of their safety blanket, markets had the worst year in 2018 since the financial crisis. Powell tried to keep up a brave face, but by the time October came around and the serious slide began, he was starting to look green around the gills.
And now he has completely capitulated.
Last night, the Fed finished its latest interest-rate setting meeting. Markets had been hoping for an indication that the Fed would take a more relaxed approach to rate rises this year. Powell delivered on that, and much, much more.
When he first started in the job, Powell explicitly pointed out that US couldn’t be expected to set monetary policy for the world. Now he’s scrapping all mention of any rate rises this year because of “cross currents” – such as slowing growth in China and Europe, trade wars, and the threat of a hard Brexit. That sounds like global monetary policy to me.
Powell had also argued that QT was on autopilot, and had little effect on markets anyway. Yet now he’s pointing out that the Fed will adjust the plan if needs be.
As the FT reports, Powell “roundly rejected suggestions by reporters that there was now some sort of ‘Powell put’ in which the Fed comes to the rescue when Wall Street is in a swoon.”
But given that everyone knew there was a Greenspan put, a Bernanke put and a Yellen put, it’s hard to believe him. Markets have tested Powell (it’s what they do), they’ve found his pain threshold, and now they’ve been reassured.
The Powell put is in place – it’s full steam ahead to the next crisis
So what does it all mean? Well, if monetary policy is loose; fiscal policy is loose; and the US economy continues to do reasonably well (once the foggy first quarter numbers are out of the way), then we’re off to the races again.
Remember – US wage inflation is still picking up. Record numbers of jobs are being created. The government is spending like nobody’s business. Sure, maybe there’s a recession somewhere on the horizon (they are cyclical things, after all). But deflation is much trickier to create when every entity with any control over the money supply is pumping more and more of it out.
A more dovish Fed means a weaker US dollar. It should also mean a steeper yield curve (as short-term interest rates fall or remain static, and longer term ones rise to compensate for expected inflation), which would help to remove fears of an imminent recession.
My colleague Dominic Frisby is writing about precious metals in tomorrow’s Money Morning, but suffice to say for now, this is a healthy environment for gold. We only need to get a tiny bit of “good” news on the political front – a truce in the trade wars; some economic stimulus from China; a Brexit that everyone hates, but can accept – to get a real rebound in the markets.
We’ve got the Powell put in place. Now it’s full steam ahead until the next crisis, which will be an inflation-driven one.
I’ll be talking about all of this with Tim Price and Iain Barnes of Netwealth at our fast-approaching event on Tuesday 12 February – book your tickets now.