“You’re not leaving much time to sort of look at each monthly release,” Charles Evans said Tuesday.
He was referring to the Fed’s 75bps rate-hike cadence, which, according to the September dot plot anyway, will almost surely continue at November’s gathering. “There are lags in monetary policy and we have moved expeditiously,” he added.
Evans was speaking to CNBC. Asked whether he was concerned about the prospect that the Fed isn’t waiting long enough to assess the impact of rate hikes on economic activity, he answered in the affirmative: “Well, I am a little nervous about exactly that.”
He was also asked directly about the pound and gilts. His interlocutor noted “evidence that what the Fed is doing is having repercussions [for] other countries, currencies and asset classes.” “Is the Fed going to break the market?” he wondered, on the way to being more direct: “Is the Fed now creating another global currency crisis or a further crisis in financial markets?”
It was a good question. As any regular reader will attest, I’ve asked it myself.
Evans paused. “This has been a very rapid increase in our short-term policy rate,” he said, before effectively refusing to answer the question. He said inflation is a problem, not just domestically, but globally. “I think this type of rate environment is going to be here for a while.”
Suffice to say the Fed isn’t yet ready to address turmoil in global currency markets in any direct, unequivocal way, although they’ll have plenty of opportunities over the balance of the week. Ultimately, they won’t be able to avoid it.
There was some respite Tuesday as bond yields fell, particularly in the UK, but I’d emphasize that this isn’t a case where a cathartic release in equities — a “throw-in-towel moment,” as Bloomberg put it — will be sufficient to clear the proverbial deck. Capitulation in stocks won’t solve burgeoning currency crises. I’m not one to toss out Jeremy Siegel quotes, but he was probably correct to suggest, on Monday, that the Fed is now “talking way too tough.”
I wouldn’t want readers to misconstrue my point, especially considering I’ve been a hawk since February 11, when I defected from the “transitory” camp in a flourish with “Jerome Powell’s Inaction Risks Irreparable Damage To Fed.” The Fed shouldn’t quit now, just when consumer inflation expectations have fallen, breakevens are down sharply and financial conditions are a one-way ticket tighter. If they can just hold the line for another six or so months, and if they get any help at all from core inflation, they may actually be able to claim some kind of Pyrrhic victory (e.g., 4-handle inflation and a 4% policy rate).
Right now, though, G-10 FX is melting down. Developed economies are at risk of spiraling import bills. The dollar’s increasingly graphic, Gladiator-style rampage has cut commodities off at the knees, but the indiscriminate nature of the slaughter means other countries won’t benefit. Have a look at the figure (below), which shows Brent in euros and pounds.
“The plunge in the pound is problematic for UK oil consumers,” Bloomberg’s Alex Longley wrote. “While Brent is now up a little less than 10% this year, it’s still up about 40% in sterling terms,” he added. “Oil refiners must buy crude in dollars, so the weakness of the pound effectively ramps up end-user prices relative to the rest of the world.”
That dynamic isn’t confined to UK oil consumers. It’s going on everywhere, and it’s precipitating a self-fulfilling spiral, where weaker currencies beget weaker fundamentals and back around, in a closed loop. If this continues (so, if the Fed doesn’t address the issue, because it’s hard to see how it resolves on its own), it’ll be self-defeating. The Fed will never make it to the peak Evans mentioned, and they certainly won’t be able to hold terminal for anything like what’s implied by the dots.
To be clear, this isn’t a dollar-funding problem. Rather, it’s an old school crisis in the making. It’s a problem “new,” macro-focused Zoltan might be inclined to write about, not an issue “old” Zoltan might pen an esoteric, technical note on.
BNY Mellon’s John Velis summed it up pretty well on Tuesday. “G-10 currencies have started to behave like their emerging market counterparts [but although] the Fed’s fight to curb inflation will likely last years, FX markets remain largely shielded from liquidity distress,” he wrote, adding that “despite all the policy uncertainty in Japan, Britain and the Eurozone, USD demand is not causing undue stress in cash funding markets.”
That’s all well and good, but, again, this is a more straightforward problem. The dollar’s too strong. And notwithstanding what looked poised to be a relief session on Tuesday, there’s every reason to believe it’ll stay strong until there’s evidence of coordination.
“Events in the UK highlight the pressure-cooker conditions facing non-USD currencies,” ING remarked. If you ask the bank’s Chris Turner, the October 12 meeting of G20 central bankers and finance ministers is now a key event for markets. “Does the FX language in the communique get tweaked to express concern over disorderly FX moves?” he wondered.
That’s more than two weeks from now. And two weeks is a long time in FX.