Ever since the late 1980s or so, the Federal Reserve, America’s central bank, has earned itself a justified reputation for being a pushover when it comes to markets.
This manifested itself in the phrase the “Greenspan put”. This was the idea that Alan Greenspan, Fed governor between 1987 and 2006, would always act to cushion markets if they looked wobbly.
The “put” survived Greenspan. His successors, Ben Bernanke and Janet Yellen, always managed to be more “dovish” than markets had expected.
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Last night, current Fed chair Jerome Powell bucked the trend. And investors didn’t like it one bit.
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Why the Federal Reserve has changed course
The Federal Reserve had its first interest-rate setting meeting of the year this week. Last night (UK time) they told us what they’d decided.
The actual decision wasn’t a surprise to markets, but the tone – showing no signs of concern about the recent market sell-off, for starters – was a lot more hawkish than investors had expected.
As a result, markets now expect interest rates to rise further and faster than they did before.
So what did the Fed say? Come March, the Fed will stop printing money to buy assets (ie quantitative easing – QE – ends). Not only that, but it’ll probably raise interest rates – maybe even by half a percentage point, not just a quarter point. Not only that, but it’ll quite likely start quantitative tightening (QT) at some point soon after that.
QT involves the Fed reversing QE. In other words, it doesn’t just stop printing money to buy assets, it starts to sell off the assets that it has already bought.
The real shift was in Jerome Powell’s tone. Markets quite often expect to get a bit of coddling from the central bank boss, particularly if rates are going up.
Not a bit of it this time. Powell emphasised that he’s worried about inflation. He emphasised that he sees inflation as a risk to workers and the labour market (usually, the labour market has been seen as a reason to keep rates low).
Most importantly, as John Authers points out on Bloomberg, “the central bank has also shown that it can live with the amount of equity market turbulence that it’s created so far”. There may well be a “Powell put”, but if there is one, it kicks in at a much lower price than investors have grown used to in the Greenspan/Bernanke/Yellen years.
What’s behind the change of strategy? As we’ve noted before, this is all driven by inflation. Powell’s predecessors had it easy. When you’re more worried about deflation than inflation, you can just print more money. That makes you popular.
Inflation is much harder to tackle. It’s now a headline issue, which means it’s a political issue (both here and in the US), which means that suddenly it’s public enemy number one, which means that Wall Street needs to fend for itself.
From that point of view, it’s better for Powell to talk tough now and get the market to tighten financial conditions for him (a stronger dollar and a weaker stockmarket are both forms of tightening), rather than leave it until he needs to do something much more drastic.
In effect, he’s hoping that a stitch today will save nine later. Because if inflation doesn’t go away, the level that interest rates might have to rise to would be very damaging indeed. So I wouldn’t expect Powell to shift course until there are either signs of serious financial distress (in credit markets say) or signs that inflation is alleviating (though I think he’d want to see more than just one or two readings before he changed tone).
What does this mean for your money? Buy banks, for one
We’ll keep an eye on all that. But meanwhile, what does this hawkishness all mean for your portfolio?
It’s easy to get caught up in the idea that a sliding US stockmarket will drive everything down with it. That’s a reasonable assumption, because it very often does.
However, the good news (for UK investors in particular) is that there are some industries that like rising interest rates. Bank stocks finally seem to be waking up from a lengthy slumber.
For example, Lloyds (which I own) is up around 5% so far this year. For perspective, the FTSE 100 – which of course also benefits from big oil, as well as the banks – is just about flat, and the Nasdaq composite is down nearly 15%. And Lloyds is far from being the only one.
It’s striking that the tech bubble and bust of the late 1990s saw the big tech companies falling out of favour and being neglected by investors for a good decade or more. After the fallout from that bubble, during the 2000s, the places to be were commodities and – in some cases – the financial sector.
Since the global financial crisis, banks outside the US have been largely neglected or treated as pariahs, certainly the boring old UK ones, which were detested by consumers (in many cases, rightly) and also subject to one of the biggest backdoor “QE for the people” schemes in history, the PPI scandal.
It’ll be fitting if the bursting of the current tech bubble (because arguably that’s what it is) coincides with a new bull market in neglected financials and other “dinosaur” stocks.
In fact, Julian Brigden of Macro Intelligence 2 Partners puts it very well in the latest MoneyWeek podcast, when he tells Merryn: “the first shall be last and the last shall be first”. You should definitely listen to this one if you haven’t yet – just click here.
