Why has the Fed called an emergency meeting?

Latest BBC business news headlines – “Martha Lane Fox joins board of Twitter” – “Brighton Pier sold for £18m” – Cameron “I could have dealt with the tax question better”. All quite fascinating and totally irrelevant compared with the news the main stream media have chosen to miss completely: the US’s central bank, the Federal Reserve (the Fed) is to hold a closed, unexpected meeting under “expedited procedures” on Monday to discuss interest rates. Now that is news!

The question is, “Why?”. Fortunately, we don’t have long to wait to find out as they will publish their discussions immediately after the meeting finishes. The rumour mill is of course in full swing. Over the past week almost anyone with a Fed lapel pin has been wheeled out to discuss the economy and to a man (and a woman) they fall into the camp that sees the glass half empty.

More and more data is coming in below expectations. The first stab at the gross domestic product (GDP) number for the first quarter is not released until the 28th but the Fed will already have a pretty good idea as the latest Atlanta Fed GDPNow forecast is just 0.1%.

The inference from all this dovish chattering is that they have realized that the rate rise was a big mistake and are about to execute a U-turn – Janet Yellen is no Maggie Thatcher!

Around the world

Their central bank colleagues in Europe and Japan followed the Fed’s rate rise by cutting rates into negative territory and announcing further quantitative easing (QE). In both cases, and in particular in Japan, the initial euphoria evaporated very quickly and instead of their currencies weakening in response to such monetary debasement, they did just the opposite!

Now along comes the Fed on Monday knowing that having announced an “expedited” meeting, the markets are going to expect something pretty unusual. A cut back to zero, or even negative, plus perhaps a fourth version of the totally discredited economic gamble known as QE would send the markets into raptures.

Bond yields would fall and equities would soar perhaps taking the S&P 500 to new highs. But how long would the party last? The last two iterations of QE had far less effect than the initial blast, which had more to do with bailing out the banks than trying to boost the economy.

Talking of banks … It is not as if the Europeans didn’t have enough to worry about and then along comes Mario with negative interest rates. This is supposed to be good news as the banks can borrow at next to nothing and lend to willing corporates desperate to partake in the dynamic economic upswing.

The only issues being that borrowers are neither willing nor desperate and the economy is far from dynamic. It is however cutting into banks’ margins and the only way out is to further penalize account and deposit holders by charging them for looking after their money. This is not how banking is supposed to work is it? No!

What can the Fed do?

At the press conference in December following the rate rise, Fed chair Janet Yellen said: “This action marks the end of an extraordinary seven-year period during which the federal funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression.” She said the economy “has come a long way”, though normalization “is likely to proceed gradually”, and “inflation continues to run below our longer-run objective”. With hindsight this was just plain rubbish; the economy has come a long way … she should have followed up saying and it’s looking very tired and now needs a good rest.

Could they be thinking of actually raising rates again? Highly unlikely. Inflation has ticked up, but is still below the long term trend and over 10 years barely above it. The jobs data is as confusing as ever but not so strong that a rate rise would be a foregone conclusion. There would also be the galvanising effect higher rates would have on the dollar exchange rate.

The odds favour more QE, perhaps allowing the Fed to buy high yield debt where there is more than a little stress right now, and maybe a cut. Either way Janet’s credibility is looking a bit suspect and we wait with “eager” anticipation for Monday’s announcement.

Clive’s postscript – We’re none the wiser

Both the Fed meeting and the Presidential debrief were “Closed to Press” so we are all none the wiser except to say that central bank activity is “hotting” up and we can expect more of the unexpected, despite “guidance” to the contrary.

In Germany, Schauble (former minister of finance) has blamed the European Central Bank’s (ECB) cheap money policy of fomenting the rise of the anti-EU AfD party, which now polls at 14%. In Germany’s proportional voting system, a party needs at least 5% to be allocated seats.

“The ECB’s policy was already unpopular in Germany and the idea of helicopter money was the straw that broke the camel’s back,” said Joerg Kraemer, an economist with Commerzbank in Frankfurt. “People feel that ideas like this are dangerous.”

While one can debate how much of Germany’s public stance is posturing, the tide is clearly turning against Draghi in Europe’s most prosperous and powerful nation. And, as Reuters adds, this weekend’s scandal marked a new low in the often fraught relations between the eurozone’s biggest country and the central bank’s Italian chief, who has recently bemoaned what he described as the “nein zu allem” – “no to everything” approach – a deliberate swipe at Germany.

The combatants will have a chance to settle their differences or continue to beg to differ at the International Monetary Fund’s spring conference in Washington later this week, and then on the 20th at the meeting of the 19 eurozone central bankers. We live in interesting times.

As things unravel, we will keep you posted…

This post is amended from a blog originally published by Clive on The View from the Bridge, 10 April 2016.