Archive for September, 2015
The big news this week, of course, was the Fed. Rarely has inaction been so exciting! The statement put out by its Board of Governors is quite pithy as these things go and worth a read in full, and the salient policy points are all sandwiched within a single paragraph as follows:
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account … labor market conditions … inflation pressures and … expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.
US unemployment for August was 5.1%, down half a point from the beginning of the year and nearer the bottom than the top of the Fed’s own range for the “longer-run normal rate of unemployment” of 4.7-5.8%. There is nothing here to justify emergency monetary conditions whatsoever. Despite the statement, therefore, the US labour market was in practice irrelevant to the decision taken by its central bank.
On inflation, the Fed notes elsewhere the “transitory effects of declines in energy and import prices”, and is absolutely right to do so. Fortunately it also has access, just like the rest of us, to “core” measures of both consumer and producer price inflation which specifically exclude food and energy. Headline CPI has crashed down from 2.1% in the spring of last year to 0.2% today, but the core measure has risen this year from 1.6% to 1.8%, not meaningfully distant from the stated target of 2%. Again, this is not consistent with an emergency monetary stance.
Having abandoned at least one and a half of the two elements of its mandate, then, the Fed has effectively announced it is acting with reference primarily or solely to an unofficial third: “financial and international developments”.
In one sense this is a masterstroke. Attributing loose policy to sources other than the domestic economy eliminates the risk of a bearish response to a downbeat assessment of the situation at home. (The Fed has come a cropper here before.) When a central bank produces an economic assessment that is news. When it points to events offshore that everyone has already seen, it says nothing new.
From another angle, however, yesterday’s decision does not look quite so masterly. Invoking the stock market as a reason for cheap money used to be known as the Greenspan Put, a source of moral hazard under the eponymous Fed chairman which attracted some of the blame for the financial crisis. And at least efforts were made to justify Mr Greenspan’s option writing in terms of a “wealth effect” on US household spending. Extending the put to the stock market in China seems startlingly multilateral even for these enlightened times.
Furthermore, all the Fed has done is postpone a move which would have taken nobody by surprise if they had done it this week. It is still perhaps a little early to gauge the market reaction but stocks are down in both the US and Europe today. The dollar has weakened just a touch against the euro, is pretty much unchanged against sterling and the yen and the Chinese yuan has not budged, so there is as yet no consoling impact for American exporters and multinationals. All that is certain is that the postponement has prolonged a key source of uncertainty.
The impact of a 25bp rate hike would have had a negligible impact on everything apart from sentiment. And it is far from clear that its market impact would have been any worse than that of the Fed’s eventual, barely defensible decision to dither.
So much for the new mandate to shore up financial and international developments.
Kudos, in conclusion, to Jeff Lacker, President of the Federal Reserve Bank of Richmond, the only one of the Fed’s twelve decision-makers to vote for a hike yesterday. His colleagues have in reality opted for nothing more cogent than mañana.
This morning’s leading headline on Bloomberg News read as follows: “Stocks Advance in Europe, Asia Amid China Holiday … ”
Without the peril of the Chinese stock market to contend with, European bourses were up by 1-2% early in the day and are higher at the time of writing. This certainly fits the narrative of those who see the collapse of the supposed equity bubble in China as the source of all the summer’s ills.
(Before moving on, a brief comment on that “supposed”. The Shanghai Composite Index rose by 58% from the start of this year to its peak on 12 June, having risen by 53% in 2014. It hit a p/e of 23.5x in the process – then began to fall. By the bottom on 26 August the drop had reached 43%. If that isn’t a bubble … ?
On the other hand that p/e was well below the 45.5x reached at the market peak of 2007 – a peak which has yet to be exceeded. And it is miles short of the 60-70x levels seen during the twilight of the go-go 1990s tech boom, and below the average level so far this century. In addition, +53% is only the fourth-highest calendar year price return for the index in the last ten years, the highest having been seen in 2006 when the market much more than doubled. Finally, the market was valued at under 10x earnings for long stretches of 2013-14 before the rally began, well below the 14x and 12x reached at the market bottoms in 2005 and 2008.
This is a febrile market which has undergone rapid change but to interpret its rally from the depressed point of mid-2014 as an egregious bubble episode is to make a glaring analytical mistake.)
Some of the actions of the Chinese government have been woefully unhelpful. Direct interventions in the stock market have exacerbated falls and sharpened investor concerns, as tends to be the way of these things. At the same time, special interests in the corporate sector have sought to manipulate the government’s response to their advantage.
Other parts of the world were in exactly the same place very recently. The SEC banned short selling of financial stocks on Wall Street from Friday 19 September 2008 – the week of the Lehmans bankruptcy – in an effort to “protect the integrity and quality of the securities market and strengthen investor confidence.” By the time the ban ended after the close on Wednesday 8 October the S&P 500 Diversified Banks index had fallen by another 22%. Christopher Cox, then Chairman of the SEC, gave an interview to Reuters after Christmas that year which contained the following little nugget:
Cox said the chief executive of one major U.S. investment bank even urged suspension of normal trading rules across the entire U.S. market, likening the situation to how Abraham Lincoln suspended habeas corpus during the Civil War and Franklin Roosevelt sent Japanese-Americans to internment camps during World War Two.
The chief executive said, “that is how America made it through such crises, and we couldn’t be too focused on maintaining the rule of law,” Cox said.
Now that is panic. When it hits markets it is perhaps understandable that policymakers are not immune.
At the same time as the SEC was floundering around trying to put the clock back, however, the US Treasury began to implement measures under the newly-enacted Troubled Asset Relief Program, including the purchase of mortgage-backed securities to assist in the repair of bank balance sheets. On 8 October 2008 the Fed cut its target rate for the first time since April of that year from 2% to 1.5% in a concerted move with the ECB, Bank of England and the central banks of Canada, Sweden and Switzerland. A month later it began its first tranche of bond purchases under QE.
The speed of the banking sector recovery in the US – as opposed to Europe or the UK – has been one of the great relative strengths of the American economy. While some actions of the American government were woefully unhelpful, therefore, others were more constructive.
Exactly the same is true of the situation in China today.
As this blog remarked over the summer, it had been ignored amid all the attention on stock markets that China’s exporters were being hobbled by the quite sudden strength of her currency against the euro (and, for that matter, the yen). Only a few days after that post was published the People’s Bank of China devalued the yuan by 1.9%, its most significant depreciation since the epoch-making 50% shift engineered in January 1994. By the end of the week the yuan was down all of 2.9% at 6.39 and has stayed close to that level ever since. A few days later the 12-month benchmark lending rate was cut, for the fourth time this year, and a further reduction in the required deposit reserve ratio announced for major banks. At this point the PBOC had fired all three monetary weapons in its arsenal in a single month.
Back in the 1990s China came to dominate production in certain low-technology sectors, such as toy manufacture, and remained a relatively small economy (still smaller than Italy by the end of the century). Through continued competitiveness, investment, innovation, and broadening into higher-tech areas such as computers and mobile phones, Chinese exports overtook those of the US in 2007 and of Germany two years later. Today China is the world’s largest exporter by a mile, with the annual pace running at $2.4trn versus $1.6trn for the US; fifteen years ago China exported about a quarter as much as the US did.
So exports matter to the Chinese economy, devaluation ought to help exporters, and monetary softening elsewhere ought to ease some of the pain in the property market and contribute to lending growth. All this is fundamentally supportive. Nonetheless, the devaluation in particular – arguably the least contentious policy response of all – was interpreted as a sign of panic and the stock market continued to fall. In other words the actual direction of monetary policy was ignored in favour of the presumed context for its loosening. This was obviously a bearish response which again has clear recent parallels elsewhere.
What must surely be only a little less obvious are the implications of this response for imminent policy action in other places. Mr Carney at the Bank of England has just dismissed the idea that the kerfuffle within and over China will throw the MPC off their envisaged tightening path for rates. In the US, speculation over the timing of the first hike in the fed funds target since June 2006 has reached fever pitch. Will it motor up to 0.5% in two weeks’ time, as the majority of forecasters currently expect? Or will there be a delay?
Most importantly for investors: would a September hike be taken as evidence of a strong recovery, or would it ignite fears that the Fed is taking away the punchbowl too soon? And would delaying until next month be seen as a welcome reprieve, or betray a conviction that the US economy’s expansion is weaker than was thought?
The consensus from market participants still seems to be that monetary tightening will be accompanied by the upward march of equity benchmarks because (a) tighter money is a sign of economic strength and (b) that’s what happened last time. But as the events of recent weeks have shown, markets can get nervous again very quickly. And the Chinese experience is a reminder that in those circumstances, even positive policy decisions are taken as a sign of something bad.
It is difficult – even, perhaps, irrational – to dislike stocks more today than before they tumbled. There does not appear to be a new recession suddenly lurking around the corner. But complacency over the ability of today’s stock markets to take higher rates in their stride sits uneasily with the reaction to China’s very modest devaluation and other policy manoeuvres.