Quick reminder, before we begin this morning: on 20 October, I’m hosting a webinar with Roland Arnold, manager of the BlackRock Smaller Companies investment trust. We’ll be talking about his views on the outlook for Britain’s smaller companies against the current backdrop of supply chain disruption and economic re-opening.
Don’t miss it (particularly if you’re a fan of small cap investing) – register for the webinar now. It’s free, and it’ll also enable you to catch up later even if you can’t watch it on the day.
OK back to today.
Try 6 free issues of MoneyWeek today
Get unparalleled financial insight, analysis and expert opinion you can profit from.
Start your trial
Sign up for MoneyWeek’s free twice-daily newsletter.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
We had a meeting of the Federal Reserve, America’s central bank, last night. It’s a sign of what a busy week it’s been that this is the first time we’ve mentioned it in Money Morning this week.
Latest Videos FromMoneyWeek
Yet this was quite an important meeting. This is when the Fed was going to give us an idea of how quickly it might try to return to “normal” monetary policy.
And the answer – surprisingly – is “quicker than you might have thought”.
The Fed talks tougher than expected
For several years – decades even – it has rarely paid to bet on the Federal Reserve being more hawkish (ie, more aggressive on tightening monetary policy) than expected. It’s usually been a good idea to bet the other way.
But yesterday, Fed chairman Jerome Powell bucked this trend. He said that it looks as though America is ready to face the “taper” (click the link to watch a video explanation of what it is, but really it just means the process of winding down quantitative easing for now).
It looks as though it’ll start from November and, by the sounds of it, if things go according to plan, it’ll be done by the middle of next year. This is faster than markets expected – and what’s worth remembering is that this is all meant to happen before the Fed thinks about raising interest rates.
So one reason for the more rapid shift on is that more Fed members – as shown by the “dot plot” (which shows when each Fed member thinks rates will be at a given point) think that the central bank will need to start raising rates earlier than it had before.
What’s also interesting is that in his press conference, Powell didn’t try to talk this back. In fact, he was very clear that – for example – it’s not going to take an absolute stunner of an employment report to make him think the time is ready to taper. He’s basically ready to do it.
So we’ve gone from a relatively dovish tone to quite a hawkish one in a short space of time. What’s changed? More to the point, why did markets basically shrug?
The answer is of course, “I don’t know”. But I can take a good guess.
One point is that the market had already reacted. I don’t agree with people who think that markets don’t care about Evergrande at all – it’s a slow burner but it’s still a biggie – but you could argue that some of the slump seen earlier this week and at the end of last was down to fear of the Fed rather than China woes.
Another is that inflation is starting to nag away at investors. They’re finally getting to the point where they’d rather see a Fed that was a) confident in the recovery and b) willing to step in to tackle inflation, rather than one that is constantly hedging and fudging and ducking the difficult questions.
Finally, we need to remember where we’re starting from. The economy (for all the concerns about Delta and about supply chains) is booming. Yet interest rates are still at 0% and will be there for another nine months. So the Fed was only hawkish in relative terms; we’re still looking at dramatically loose monetary policy.
The Norwegian central bank is already tightening up
It’s also worth looking at what’s going on elsewhere in the world. The focus on the Fed can be quite distracting. Obviously, there are good reasons for watching the US central bank more closely than any other (even our own Bank of England). The dollar is the reserve currency (put simply, the most widely-used currency), and that puts the US at the heart of the economic world.
The Fed can’t open its mouth without potentially moving markets across the globe. So yes, we very much have to keep an eye on it. However, when we’re at turning points like the current one, it’s also worth keeping an eye on what everyone else is doing. For example, this very morning the Norwegian central bank (Norges Bank) has raised interest rates from 0% to 0.25%.
As Bloomberg points out, of the ten countries with the most-traded currencies, this makes Norway the first to raise rates following the pandemic. New Zealand looked set to be the first but then someone sneezed in Auckland and the whole thing was called off.
Anyway, the move was expected. The Norwegian economy has, like most others, rallied sharply now that we’re getting past the worst of the pandemic. In fact, the economy is now doing better than it was before Covid hit.
But Norway has one big added benefit that the others don’t have – a massive sovereign wealth fund stuffed with oil wealth, which means that, unlike its peers, the national balance sheet looks pretty healthy too.
So you can’t read across from Norway directly to the rest of the world. However, the direction of travel is clear. If the rest of the world’s central banks start tightening – gently – relative to the Fed, that might even be good news for markets. It implies a weaker dollar which is almost always good news for asset prices.
As for inflation – it’s either transitory or it isn’t. I believe it isn’t. And if that’s the case, it’s going to take more than a quarter-point rate rise nine months from now to stop it.
PS, we’ll have more on all this in forthcoming issues of MoneyWeek (subscribe now and you’ll get my book thrown in too – bargain!). And if you haven’t registered for my webinar with BlackRock Smaller Companies trust yet, don’t forget to do so.
