What A Mess
By Michael Every of Rabobank
I start the Global Daily today with the concluding comment to our Fed-watcher Philip Marey’s post-FOMC note titled ‘Credit Tightening’:
“A final observation. The Fed continues to stumble its way through the fight against inflation. First they tried to explain inflation away by claiming it was transitory. Consequently, they were late in starting the hiking cycle. Now that they are finally approaching positive territory for the real federal funds rate, they are close to ending the hiking cycle and leaving the rest of the fight against inflation to credit tightening by the banks. Because the Fed in its regulatory role failed to prevent the recent banking turmoil. Failing as a central bank on both fronts, so now it’s up to the banking sector to get inflation under control? What a mess.”
Except it’s even worse than that. The Fed hiked 25bps and shifted language such that Philip now sees only one more 25bps step in May. So, closer to a pause. Yet, as I kept saying a few months ago, this is ‘the pause that doesn’t refresh’. Indeed, the 2024 median dot plot was increased from 4.1% to 4.3%, and those cuts were stressed as contingent on inflation coming down, when the UK yesterday showed CPI is quite capable of suddenly surprising to the upside again.
Moreover, while Fed Chair Powell was underlining that the US banking system is safe and sound, Treasury Secretary Yellen --who doing Powell‘s job in 2017 told us there would not be another financial crisis “in my lifetime”-- was telling markets the FDIC would not extend deposit insurance, increasing the risks of outflows and credit tightening. It would be nice if Powell and Yellen coordinated their policies rather than working in opposite directions, as yesterday, and over QT vs. the TGA.
On the credit tightening front, plucked from FinTwit: “This was the first week of [Citi credit card] data following the disruption within the financial sector, and we were curious if it might have had an impact on the consumer. It sure did….[seeing the] biggest decline in total retail spending .. since the pandemic began (April 2020).” If that trend continues, pressures for greater action, and institutional coordination, will only build.
On which, if you think what we have now is a mess, try the Bloomberg long-read about coming paradigm-shifts in banking and central-banking: ‘Finance is going back to the age of mercantilism’. It makes arguments regular readers of the Global Daily will immediately recognise, is of juicy quotes, and worth reading in full, but a summary runs:
“Since the history of financial regulation is a history of crisis management, it is inevitable the current chaos in the financial sector will bring forth new rules designed to prevent a repeat. Already, there is a debate on whether there is a better way to govern banks. On one side are those who think depositors should be protected even more fully; on the other are those who say bailing banks out leads to moral hazard.
There is some optimism that the rule changes may not be as dramatic as after the crisis of 2008, mostly because banks have much more capital now. But, as John Micklethwait and Adrian Wooldridge point out, regulators are also operating against a very different global backdrop. In 2008, governments everywhere were committed to a liberal finance system. Now the world’s economy is breaking up into competitive regional blocs, and political rhetoric has shifted toward creating national champions and directing consumers toward local providers. The idea of finance as an arm of the state is back.
The post-crisis restructuring this time will likely reflect this new mindset: a mercantilist form of finance, in line with the statist policies of modern geopolitics. Already, banks are becoming more intertwined with governments, which in turn are picking winners and trying to back the industries of the future. Politicians welcome this because it increases their control over the economy.”
Consider, hypothetically, what that implies for rates. In 2018’s deep dive into the economic strategy of Europe’s Great Powers, I argued the country with the lowest cost of borrowing emerged the winner. That’s true if Great Power struggle-relevant production is funded by it: but not if commodity bubbles or consumer appetites are. Moreover, if a rival mercantilist bloc leans on commodities as an anchor (as Brazil’s President Lula heads to Beijing on March 28 with 240 business representatives), then the risk is that US rates need to be higher, not lower, as a defence or offence. Of course, there would have to be credit exceptions for key Great Power sectors (‘Pentagon Creates Cell to Oversee Expansion of Weapon Production Lines’): so we end up with ‘rate hikes and acronyms’ – which, like mercantilism, is the historical norm, not neoliberalism.
Of course, one can push back:
In the US, Senator Warren tweets: “The Fed under Chair Powell made a mistake not pausing its extreme interest rate hikes. I've warned for months that the Fed's current path risks throwing millions of Americans out of work. We have many tools to fight inflation without pushing the economy off a cliff.” Such as…? (And see the reply to her Tweet immediately below.)
NBC news wails ‘TikTok ban would be 'a slap in the face' to young Democratic voters, activists warn: Gen Z voters lean overwhelmingly Democratic, but some Democrats warn they'll stay home if the White House bans their favourite app’. Expensive lobbying efforts are getting results – but too little too late?
In Germany, Handelsblatt reports Deutsche Telekom has been helping Huawei circumvent US sanctions after Deutsche Bahn opted for Huawei for their train control system. Meanwhile, a Bundestag report says at the present rate of rearmament, it will take Germany until 2073 to achieve the shift to military preparedness it pledged in 2022. In short, there may be an extra D --Deutschland-- missing from the recent CSIS ‘Deny, Deflect, Deter’ report on China – though the tech export controls flagged yesterday do suggest mercantilism, not Merkelcantilism.
No matter what kind a mess you think the Fed is in today, those looking at things from a ‘Grand Strategy’ perspective are even more worried.
