Jerome Powell is sorry – not sorry.
Emerging markets are crumbling and if you don’t like hyperbole, then let’s just call it “cracking.”
Brazil is in trouble (it took a promise to “flood” the market with dollars to stem the BRL’s declines on Friday after a truly harrowing crash towards 4.00 on Thursday), Turkey has hiked three times in three months (two LLW hikes and Thursday’s hike under the simplified policy regime that was itself a crisis response, albeit long overdue), Argentina has been forced into the arms of the IMF after a series of draconian hikes failed to arrest the plunge in the peso, Indonesia has hiked twice in a month and new Governor Perry Warjiyo recently joined the RBI’s Urjit Patel in imploring the Fed to consider the knock-on effects of more rate hikes for emerging markets. On Friday morning, the rand took the baton when it comes to EM FX turbulence. This sums it up:
One certainly wonders whether Jerome Powell is reconsidering the following comments he made at an IMF/SNB event early last month:
Monetary stimulus by the Fed and other advanced economies played a relatively limited role in the surge of capital flows to (emerging market economies) in recent years.
There is good reason to think that the normalization of monetary policy in advanced economies should continue to prove manageable for EMEs. Markets should not be surprised by our actions if the economy evolves in line with expectations.
He has to have known that first bit about accommodation in DMs playing “a relatively limited role” in capital flows to EMs is bullshit. That’s a patently absurd contention to make and surely he understands the points made in the post linked above by the RBI’s Patel about the extent to which the Fed’s normalization of the balance sheet is exacerbating the supply/demand distortion created by the deluge of Treasury supply (necessitated by Trump’s tax cuts) and thereby fostering a shortage of dollar liquidity.
But again, as long as the U.S. economy continues to fire on all cylinders (and if that’s a debatable characterization, let’s just pretend like it’s unequivocally true), Powell doesn’t seem predisposed to being easily deterred. The May jobs report is likely to have emboldened him further and the prospect of late-cycle fiscal stimulus causing the economy to overheat is almost certainly contributing to the Fed’s determination to stay the course.
All of that despite the fact that this always ends the same way.
From Algebris’s Alberto Gallo:
The standard explanation for the repricing in risk premia we are experiencing is the withdrawal of central bank liquidity by the Federal Reserve. Historically, this has coincided with unwind of carry trades and bursting of financial asset bubbles.
From SocGen’s Albert Edwards:
Since 1950, there have been 13 cycles in which the Federal Reserve tightened interest rates and 10 of these ended in recession. The other three tightening cycles saw emerging market blow-ups, like the 1994 Mexican peso crisis.
But again, Powell is sorry – not sorry.
This week, the Fed will hike. If they don’t, it would mark a rather stunning relent that would say something not at all good about how worried the committee suddenly is about the fragility of EM.
Here’s a snapshot of how the key data has evolved since the March and May FOMC meetings:
“Taken together, we think Fed officials will view the economic data since the March SEP meeting as additional evidence that fiscal policy is boosting growth and that inflation is returning to target,” Goldman writes, in their FOMC preview, adding that “with any lingering doubts around these two issues fading, the Committee is likely to refocus its attention on the consequences of the sizeable labor market overshoot.”
Here are Goldman’s projected changes to the SEP:
As you can see, Goldman sees an upgrade to the 2018 inflation projection and upgrades to the unemployment forecasts. The bank also sees an upward shift in the dot plot.
Here’s Barclays’ take:
At 3.8%, the unemployment rate already stands at the median committee member’s projection for year-end. We expect the June SEPs to contain a downward revision to the path for unemployment by about 0.2pp. Therefore, something has to give; either the committee revises its inflation forecast higher, revises lower its estimate of long-run unemployment, or steepens the appropriate policy path. Based on recent communications, we think the committee is more likely to project a modest overshoot of its 2% inflation target than it is to steepen its expected policy path. Hence, we look for the median policy rate path – which currently points to three 25bp rate increases in calendar year 2018 and three additional hikes in 2019 – to remain unchanged at this meeting. We retain our outlook for a total of four rate hikes this year, but believe it to be too early for the committee to signal that intention now; the committee has room to let inflation drift higher.
For their part, BofAML is out upping their Fed call. They’re now calling for a total of four hikes in 2018 (from their previous forecast of three) based on “solid” incoming data, the market’s resilience to Italy and EM turmoil, and what they perceive as a hawkish lean in the Fedspeak. As for this week’s meeting, here’s their call on the SEP and the dots:
We expect the median dots to remain unchanged from the March projections, leaving the current projections for 3 hikes this year and next. While the fedspeak has brightened since the March meeting, we believe those who have priced in 3 hikes this year are likely to wait for more clarity on tail risks before shifting to four. It’s a close call though as it would only take one dot to push up the median to 4 hikes. The median dots for 2019 and 2020 should remain unchanged as it would take 2 and 3 dots to shift higher, respectively. However, the distributions could adjust lower as some Fed officials have discussed the possibility of pausing once hitting neutral.
We expect modest adjustments to the economic outlook, marking the forecast to the latest data. On growth, we think the median will likely adjust slightly upwards given the solid growth data since the March meeting. We also think that the estimate for long-run GDP growth moves up a tenth as more officials see trend growth gradually moving higher. With the unemployment rate already hitting 3.8% in May, we expect Fed officials to revise down the entire path. We expect the median forecast to look for the unemployment rate to hit 3.6% by the end of this year and shift lower in 2019 and 2020 to 3.5%. We expect little change in the core inflation forecast as the data have broadly evolved in line with expectations, though headline inflation is likely to edge up to 2.0% this year given the recent rally in energy prices.
And here’s BNP, just to give you one more take on this:
We think the Committee will mark up its median 2018 GDP growth forecast by a further 0.1pp on the back of stronger-than expected consumer spending data. With the unemployment rate currently sitting at 3.8% – the same level as the Committee’s current average Q4 forecast (and nearly 3.7% on an unrounded basis), we also expect it to mark down its unemployment rate forecasts by another 0.1pp for all years, and think we could see another downward revision to its NAIRU estimate, which is 0.8pp above the current unemployment rate.
Despite these economic upgrades, we do not expect a change in the median interest rate projections. In March, the Committee was on a knife edge for its 2018 rate projections, with five participants projecting three hikes and five projecting four. Thus, it would only take one participant in the three-hike camp to shift to four in order to move the median “dot” higher. Recent Fedspeak has not signaled this shift, though we do not rule it out.
We continue to expect the Committee to hike a total of four times this year, and think that strong activity and higher inflation between now and September could push more participants into the four-hike camp for 2018 at the September meeting.
As for the statement, there’s a pretty broad consensus that the dovish forward guidance (i.e., “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run”) could be removed.
Barclays suggests a wholesale reworking of the format to more closely resemble pre-crisis statements may be in the cards, but beyond that, the economic outlook is likely to be sanguine, although it’s possible they’ll be an addition that in some way references external events (i.e., Italy and emerging markets). That would probably be a welcome sign for EM, even if it’s largely meaningless.
One other question is how the Fed will approach the burgeoning trade conflict. Even if it’s not mentioned explicitly in the statement, it will almost surely come up in Powell’s press conference which will itself be parsed relentlessly and probably benchmarked to his first presser in order to see if he sticks to his – how should I put this? – terse demeanor and penchant for eschewing academic discussions for straightforward (and not always comforting) answers.
Finally, they’ll be an explanation of the IOER tweak in the implementation note (see the May minutes).