A key consideration when you ponder the prospect of a global financial meltdown, is the notion that market participants actually want to push things in that direction in order to compel policymakers to respond.
On Friday, as the pound drowned and gilts plunged in an EM-style synchronous implosion, I wrote, in response to a reader: “There’s some serious blood in the water. If speculators want to push the issue, they could trigger a crisis.”
That may be the whole point. The Fed is laser-focused on domestic inflation. Jerome Powell’s myopia is understandable. He’s under intense political pressure and is keen to reestablish credibility with lawmakers and the electorate. When asked about other economies and policy in other locales during September’s post-FOMC press conference, he brushed the issue aside, although he wouldn’t agree with that characterization.
“A number of commentators have come to the view that simultaneous global tightening around the world creates the risk of a global recession that’s worse than is necessary to bring inflation down,” Axios’s Neil Irwin said. “How do you see that risk [and] how do you think of coordination with your fellow central bankers?”
Powell delivered a well-meaning response, long on assurances but conspicuously short on alarm. That’s potentially problematic because, as we saw this week, the Fed should be alarmed. The dollar is on a veritable rampage, with dramatic consequences not just for emerging markets, but for Japan, Europe and the UK.
“We are in pretty regular contact. We regularly discuss what we’re seeing in terms of international spillovers,” Powell told Irwin. “We are certainly aware of what’s going on in other economies around the world and what that means for us and vice versa.” The Fed, Powell said, tries to “take all of that into account” and “bake it into” forecasts, but he conceded that the Committee’s efforts in that regard “won’t be perfect.”
“It’s hard to talk about collaboration,” Powell went on to say. He assured Irwin that the Fed’s contact with its global counterparts is “more or less ongoing.”
That’s good, because it’ll need to be. The UK is already in an economic crisis and now sits on the brink of a financial meltdown. The EU is grappling with an existential energy crisis. And Japan has been forced, both by US monetary policy and by its own monetary policy, to intervene unilaterally in the currency market.
If you ask BofA’s Michael Hartnett, market participants might be inclined to brinksmanship if it means compelling officials and world leaders to get serious about coordination. He harkened back to 1987, mentioning James Baker’s back-and-forth with Karl Otto Pohl as a way of completing a checklist of supposed parallels. “All that’s missing is a sudden reversal in everyone’s favorite US dollar long,” he wrote.
I’m not sure that analogy works perfectly or works quite in the way he seems to think it does, but that’s not really the point. The point, rather, is that “investors have an incentive to push the envelope” on various crises ahead of what Hartnett aptly described as an “utterly crucial” G20 in November.
It was a reiteration of remarks he made earlier this month, when he called the November 15 gathering in Bali “hugely important” in light of “new market, macro and geopolitical” realities. Hartnett also suggested markets “may pressure policymakers” for a new FX accord given ongoing tumult in currencies. Since then, things have escalated materially on that front.
Writing in his latest, Hartnett said investors “want policy coordination and policy credibility. “Until they get it, they’re likely to press shorts,” he warned.
I think that risk is underappreciated, particularly at a time when any such “pressing-shorts-to-save-the-world”-like behavior has the potential to collide with guide downs and profit warnings from corporate America, not to mention additional escalations in Ukraine, where territories controlled by Russia are in the process of “voting” for annexation.
Investors are staring down a very daunting two months. The G20 will be an opportunity for world leaders and officials to demonstrate something in the way of goodwill and competence. I’m not optimistic.
It’s seems that policy, excluding the boj, is coordinated. Everyone is putting in oversized hikes attempting to get ahead of or at least keep pace with the Fed. We’re all trying to export inflation or at least avoid importing it.
What do we mean by ‘policy coordination?’
What does that look different that what we have?
Last question should read: how does that look different from what we have?
I’ll throw another one out there, are we to presume that central banks are not currently communicating/coordinating with one another already?
I more or less agree. Japan excluded, all CBs are in hiking mood, all to fight the same inflation.
What I think H. is hinting at is that greater coordination amongst politicians (i.e. around the fiscal tools) is needed. And the CBs, by hiking and market participants, by shorting everything, are trying to bring that about?
So lets say that policymakers do decide to coordinate in the future in the face of some crisis, and work to limit or reverse the dollar’s gains relative to other currencies. What actionable impacts would that have? Here are my guesses:
Bullish for commodities. They are valued in dollars and so everyone else can now afford more of them.
Bullish for ADRs of international companies, at least relative to US indices, since the ADRs are valued in dollars.
Inflationary in America, but deflationary elsewhere, thus bearish for treasuries and bullish for international bonds?
Bullish for American equities? The inflationary impulse argues against this take, but it would essentially be an easing of monetary policy, and might be interpreted as a “pivot” of sorts. It would also improve international sales of American companies, likely making margin headwinds better.
Any thoughts or critiques?
There’s a tension between weakening the dollar and taming inflation. Both can only happen if other nations hike rates to extreme levels.
It’s not as much a coordination as others just need to slap a premium yield over the Fed’s targets. For a foreign currency to remain in balance with the dollar, the premium needs to grow larger the higher US rates go.
How much should a 2-year UK bond yield for you to buy it when a 2-year Treasury yields 2%? How about when the 2-year Treasury yields 4%?
Such coordination is out of the Fed’s hands and dollar weakening depends on how deep a recession others are willing to stand. The US hegemony is reasserting itself.
It’s actually what happens between now and the point at which the Fed have to capitulate that’s the risk in my opinion. As has been pointed out in one of Mr H’s articles, the point at which rates in Europe become restrictive is much lower compared to the US, so if they are forced to go up, as they did in the UK it could be problematic. 2 year UK rates increased by almost 33bps on Friday, at a guess that’s probably a 3 standard deviation move. I am not close enough to investor positioning, but with big moves like this I’d imagine there could be some expensive margin calls. Increased volatility would also lead brokers seeking additional margin. It’s the point at which liquidity dries up that things could get out of hand, but I don’t a have handle on how close we are. US high yield spreads are still below 5%, although they have been increasing. They went up to 6% before the Summer rally and by way of comparison were around 10% during the peak of the COVID crisis.
What’s needed, I think, is some coordinated effort to put a brake on dollar strength, but as a couple of you alluded to, that’s somewhat difficult right now given inflation realities in the US. But the key is that “coordinated” rate hikes is kind of a misnomer. It’s more coercion that coordination. Yes, central banks are all concerned with domestic inflation. And yes, some central banks started earlier than the Fed. But the Fed (effectively) sets monetary policy for the world. This idea that other central banks are “free to pursue” their own monetary policies is mostly a myth. One corollary is that when the Fed’s executing consecutive rate hikes, “out-hawking” them is mostly impossible, especially considering the safe haven status of USD assets in a risk-off environment. Currently, this has the potential to sink entire economies through soaring import bills and terms of trade shocks. Expensive fiscal policy in other locales is making this even more complicated. At some point, the Fed will have to address this with other central banks. The pound and the euro and the yen can’t just keeping going lower and lower and lower and lower forever, and if commodity prices spike again against these ever weaker currencies, it’ll be a total debacle. Look how the market treated UK assets on Friday. Now imagine what would happen if wholesale gas prices surged to new records on some escalation in Ukraine. Truss is on the hook to cover that given the energy price cap she instituted. With Japan, if US yields keep rising and Kuroda sticks with the current YCC band, he’ll be printing yen every day. The MoF risks exacerbating US rate rise by selling massive amounts of Treasurys to intervene. That could overwhelm the effect of the intervention if it pushes up US yields — it could exacerbate rate differentials. The G7 needs some kind of agreement on all of this. But I think what Hartnett is referring to in addition to that is something more broad where that means a Ukraine resolution, etc. That isn’t coming, though. Putin’s too lost. He’d want concessions and NATO, let alone Ukraine, won’t be keen to give him any. Somebody wrote an Op-Ed for Bloomberg the other day suggesting the West and Kyiv just give him the regions he controls now and declare the unoccupied parts of Ukraine a part of NATO. It was a silly suggestion.
As a funny aside, the title of a recent TD BoC piece was “Keeping Up With the Jeromeses.”