..last week showed that interest rate policy has the greatest ability to roil the markets, not geopolitics, not assassination attempts nor election outcomes.
..the Fed showed that it can still move markets in a big way, so Powell has the power to jawbone markets, barely impotent.
..now what would Trump do under Trump 2.0 - will he allow the likes of Elon Musk and Jerome Powell to be greater influence and power than himself? The Federal Reserve’s hawkish pivot is toxic for stocks
The US central bank’s belated acknowledgement of re-accelerating inflation and the risks flowing from Donald Trump’s policies could trigger a sustained market downturn. Christopher JoyeColumnist
Dec 21, 2024 – 5.00am
There is very bad news for risky assets in the humiliating policy reversal that a politically compromised US Federal Reserve has had to effect since the November presidential election.
And the clear signal is in the savage price action: the S&P500 Index slumped more than 3 per cent after the Fed’s decision to significantly raise its inflation forecasts, increase its estimate of the so-called neutral (or normal) interest rate, slash by half the number of cuts penciled in for next year, and its about-face that the balance of inflation risks now lies to the high, rather than the low, side.
This has been precipitated by a predictable re-acceleration in US inflation coupled with the Fed’s belated recognition of the risks posed by the new president’s policy program, which is highly inflationary.
“The improvement in US inflation has gone into reverse, with annual core inflation likely to end the year at 2.9 per cent, well above the Fed’s 2 per cent target and up from a low of 2.6 per cent in the middle of the year,” Kieran Davies, Coolabah’s chief macro strategist, says.
As recently as September, the Fed was naively projecting that its preferred measure of core inflation would end the year at 2.6 per cent. It has now been compelled to revise that up to 2.8 per cent, and we are projecting a higher number again.
This would be the fourth year in a row that the Fed has missed its inflation target by a large margin, and it does not now expect to meet that target until 2027 (previously it said it would get there in 2026).
On Thursday, new data was released showing that the US economy grew by a very rapid 3.1 per cent (annualised) in the September quarter, miles above the Fed’s estimate of trend growth, which is just 1.8 per cent. All else being equal, US economic activity is incompatible with the Fed hitting its target.
It is entirely possible that the world’s most important central bank will be forced to lift rates again next year, which would be devastating for listed equities, cryptocurrencies, commercial property, private equity and risky debt valuations, among other things. Dramatic but unsurprising
Analysis of the opinions of Fed committee members reveals that they have swung from believing that the future inflation outcomes were evenly distributed around upside and downside scenarios in September to now fretting that most of the risks are skewed to the high side again.
Indeed, the Fed’s concern about upside inflation hazards almost matches the extremes reported in 2021-2022 when consumer price pressures were soaring to the highest levels observed since the 1980s.
In September, only three Fed members were worried about the spectre of inflation overshooting. This month, that number leapt to 15 members, accounting for most of the 19-person Fed committee. It is a truly dramatic yet unsurprising turn of events.
Some Fed members concede they regret their aggressive 75 basis points worth of rate cuts in September and November, which were partly motivated to provide a tailwind of support to the incumbent administration given the relentless hostility Donald Trump had directed at the central bank and its chairman, Jerome Powell.
Cracks within the institution have started to materialise, with dissenting votes that opposed cuts emerging in September and December. Disagreement on the direction of interest rates has been relatively rare under Powell’s consensus-focused leadership. In fact, four of the 19 committee members argued in favour of no further rate reduction in December (only one, however, was a voter). Trump policies’ impact
This column previously asserted that the Fed was crazy to slash rates just before a line-ball US election, which was inconsistent with its historically apolitical posture and particularly imprudent given how profound Trump’s policy changes would be.
Recall the Peterson Institute’s modelling of Trump’s core proposals, which pointed to a seven percentage point increase in the US CPI index, which in isolation would warrant the Fed lifting its policy rate about 3.75 percentage points higher than the counterfactual scenario involving no Trump presidency.
The US 10-year government bond yield, which is the global benchmark for the price of money, has jumped 100 basis points from 3.6 per cent in mid-September, when the Fed started slashing rates, to almost 4.6 per cent at the time of writing.
This column has always liked averaging into US fixed-rate duration exposures when the 10-year yield pushes above 4.5 per cent. And it is plausible that these yields could test 5 per cent again, which would probably send stocks another 10 to 20 percentage points lower.
With a dovish Reserve Bank of Australia indicating that it may begin a gradual process of reducing rates in February, the Aussie 10-year government bond yield has fallen about 10 basis points below its US counterpart, contributing to the sharp decline in the Aussie dollar, which has plunged to US62¢.
While this is, at the margin, somewhat inflationary as import prices climb, it does make our domestic industries more globally competitive while materially enhancing the appeal of local assets, which have suddenly become cheaper for offshore buyers who are long US dollars.
Although the RBA appears minded to bequeath some interest rate relief next year, it seems likely we will remain in a higher-for-longer climate relative to the pre-pandemic path, which will be a challenge for cyclically sensitive sectors.
The number of bankruptcies being reported in Australia, New Zealand, the UK and the US is the highest since the 2008 crisis. This is a troubling development for lenders to so-called sub-prime borrowers who cannot access finance from traditional banks.
Almost every week The Australian Financial Review reports new private credit fund problems, which are bound to get much worse as non-bank borrowers wilt under the pressure of a lofty cost of capital.
Our research on the default rates suffered by bank and non-bank borrowers suggests that the latter have a 2.5 times higher probability of missing repayments on their debts. And this is playing out right now in the default rates disclosed on securitised non-bank home loan portfolios, which are near their historic highs.
Times are especially tough for lenders to commercial and/or residential property developers with projects in Victoria, which is experiencing a free-fall in real estate prices while the rest of the country profits from the shift of people and capital out of what increasingly resembles a failed state.
Victoria has gone from having relatively little public debt before the COVID-19 pandemic and possessing a globally prized AAA credit rating to owing the world more than $260 billion by 2028. And its current AA credit rating could easily fall below that of the big banks unless radical fiscal repair is embraced.
Paying 5.5 per cent or higher interest rates on a $260 billion debt bill would equate to more than $14 billion in annual interest repayments, or almost half what the federal government spends on Medicare each year. It is a colossal failure of fiscal responsibility.
Next year could be a very tough one for cyclically sensitive asset classes if central banks cannot deliver on their bold plans to aggressively ease rates. And heaven help the risk junkies if Trump’s trade war does trigger a re-acceleration in inflation, which could warrant a resumption of rate rises.
