Markets Are Being Lulled Into A False Sense Of Accommodation

Authored by Steven Guinness,

Those who take an interest in the actions of central banks will know that the advent of Brexit and Donald Trump’s presidency has seen the direction of monetary policy gradually change in both the UK and the U.S.

Since the EU referendum, the Bank of England have raised interest rates twice, after initially cutting them and implementing a new round of quantitative easing in the aftermath of the vote. The first rate hike in November 2017 came over a decade since the bank last increased rates in July 2007.

A month after Donald Trump was confirmed as the 45th American president, the Federal Reserve raised rates for only the second time in nine and a half years. Since Trump’s inauguration, they have gone on to hike a further seven times, and over the course of eighteen months (starting late 2017) the Fed have rolled off over $600 billion in assets from its balance sheet.

As the Fed continue to roll off assets until their balance sheet ‘normalisation‘ programme ends in September, the sentiment amongst traders is that the central bank will soon begin a course of rate cuts in order to stave off the threat of a recession as the prospect of a full blown trade conflict with China and other nation states gathers momentum.

A similar sentiment can be found in the UK over Brexit. With the British economy stagnant and manufacturing and construction sectors in decline, there exists an expectation that the Bank of England will ultimately reverse course if an economic downturn takes hold.

There is what you might call a precedent for this. The BOE and the Fed cut rates to near zero percent in the midst of the 2008 financial crisis. Surely they would seek to accommodate markets again in the event of another breakdown? In my view this is a dangerous assumption to make.

So as not to arouse widespread suspicion for their actions, central banks have embarked on a carefully regimented programme of increased levels of communication over the past few years. To quote Bundesbank President and Chairman of the Board at the Bank for International Settlements, Jens Weidmann, communication has become an ‘instrument of monetary policy‘.

You may have picked up on how since the Fed raised rates in December 2015, they along with the Bank of England have only adapted monetary policy when a meeting has coincided with a press conference afterwards. The BOE carried out their post referendum rate cut and two subsequent hikes when delivering their quarterly inflation report. Likewise, the Fed have announced each interest rate rise in line with their own quarterly summary of economic projections. They used the same setting to announce their balance sheet reduction scheme in 2017.

Whilst the Bank of England only communicate monetary policy directly when issuing an inflation report, the Fed as of January 2019 now hold a press conference after every FOMC meeting. This has opened up the possibility that any of the scheduled eight meetings per year could be construed as ‘live‘ meetings, meaning monetary policy could change more regularly now that the channels of communication have been expanded.

So far, decisions emanating from the BOE and the Fed since 2015 have proven predictable. This is due to more regular media interaction from members of the central banks, which typically increases in the run up to an interest rate decision. Traders and the public alike have yet to be taken by surprise from any interest rate move over the past four years. All decisions were telegraphed weeks in advance.

As Jens Weidmann has commented, ‘communication serves to steer expectations‘. We saw a clear example of this before the Bank of England raised rates in 2017. In the months prior, numerous members of the bank’s Monetary Policy Committee took to the airwaves, appeared on television and gave speeches to acclimatise people to the fact that rates were about to rise for the first time in over ten years.

We see the same process in motion today.

Beginning with the Bank of England, last week chief economist Andy Haldane wrote in The Sun newspaper to warn that a further rise in interest rates was edging closer.

For me personally, the time is nearing when a small rise in rates would be prudent to nip any inflationary risks in the bud.

With spending by both households and companies picking up, that could put at risk the Bank of England’s 2% inflation target – with upward pressure on prices eating into pay and savings.

As reported by several outlets, Haldane’s assertion is that inflationary pressures will mount once the uncertainty over Brexit negotiations are resolved. I first wrote back in January 2018 that the BOE’s mandate for 2% inflation has become central to their justification for tightening policy, whereas in the years that followed the 2008 crisis they allowed inflation to rise to a high of 5.5% without raising rates. Instead, they carried on pumping more artificially created money into the system, despite inflation running over 3% above target.

The situation now is different. As uncertainty over Brexit intensifies along with the prospect of the UK leaving the EU with no withdrawal agreement, the BOE remain steadfast that they will conduct monetary policy in line with their mandate for 2% inflation.

To support this thesis, governor Mark Carney appeared before the Treasury Select Committee in September 2018 and gave a very frank assessment of what would most likely happen in the event of a ‘disorderly‘ Brexit. Discussing the possibility of a no deal / no transition scenario, Carney said:

In the scenario you’re discussing, you have a potential exchange rate impact and a direct tariff pass through impact, and potentially some supply disruptions.

We have a very clear remit to bring inflation back to that 2% target. From a monetary perspective, we would look – subject to our remit – to do what we could to support and ease the adjustment. But there are limits to our ability to do so.

This scenario we’re talking about is quite an extreme scenario. It’s very easy to see a case where those tolerances would be breached and policy would have to be tighter not looser.

Does this sound like a central bank that will backstop the fallout of a no deal outcome, and in so doing abandon once again its inflation remit? I would contend not. 3% inflation was the limit for the BOE when they raised rates in 2017. Judging by their own analysis, they anticipate inflation to rise to over 6% off the back of no deal.

Should they remain committed to their 2% mandate, as I believe they will, rates are only going one way.

Markets and mainstream economists have called Carney’s bluff. They do not believe that the Bank of England would raise interest rates in the wake of a no deal outcome. It is a position based on hope rather than actual evidence. The question they have neglected to ask is why amidst Brexit uncertainty the bank remains resolute behind it’s inflation mandate, whereas in the years previous it did not garner the same level of importance.

As I have remarked before, you either have a recognised mandate for inflation, or you do not. What the Bank of England are doing is turning on the relevance of inflation targeting when the time suits.

Whilst UK markets expect the BOE to accommodate a ‘hard‘ Brexit, the U.S. expects the same out of the Federal Reserve when it comes to trade tariffs. Earlier this month a comment from Fed chairman Jerome Powell was widely interpreted by traders as a sign that the central bank was about to cut interest rates.

Here is what Powell said:

We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labour market and inflation near our symmetric 2 percent objective.

Note how Powell referenced the Fed’s objective for 2% inflation. In reality, this is not a clear indication of an imminent reversal in monetary policy. It has more in common with the position of the Bank of England, who have long communicated that rates could move either way over Brexit depending on the inflationary ramifications.

Nevertheless, a majority of the mainstream and independent media have chosen to ignore this. Instead, they are promoting the falsehood that the Fed has already reversed course, even though the bank continues to reduce its balance sheet and interest rates have remained static for six months.

There is a simple dynamic at work here. Trade is the one entity that connects the UK’s withdrawal from the EU and the tariffs imposed by the Trump administration. An economic consequence of both will prove to be a rise in inflation, to levels that comfortably exceed the BOE’s and the Fed’s 2% mandate.

One argument is that both central banks will ultimately cut rates to zero – perhaps even to negative territory – and fire up quantitative easing again to maintain the false recovery narrative that grew out of 2008.

What this argument does not factor in is how the rise in populist and nationalist sentiment over the past few years is providing central banks with adequate cover for their actions. By choosing now to thrust their inflation mandate to the forefront of their remit, they are saying to markets that there is only so much we will tolerate before being forced to take action.

As for how political protectionism could benefit globalists, former Deputy Director of the International Monetary Fund, Mohamed El-Erian, suggested back in 2017 that the growth in populism and nationalism could provide the impetus to ‘revamp’ the IMF’s Special Drawing Rights basket of currencies.

Now we begin to see a vision for how Brexit and the Trump administration work in favour of global planners. Their own communications, for which are plentiful, present a clear agenda for the future implementation of a global currency framework within the next decade. Such a framework could only be achieved by diminishing the current standing of national currencies, notably the dollar and sterling. The role of sterling as a reserve currency has already been called into question as a result of Brexit. The world reserve status of the dollar is also coming under greater scrutiny.

Assimilating currencies through the IMF’s SDR would act as a pathway towards the creation of a global currency that transcends national boundaries.

By using the metric of inflation in accordance with their mandates, central banks have the ability to engineer a financial collapse and escape culpability for their actions.

Backstopping Brexit and Trump would not assist the globalists with their ambitions. I do not believe that maintaining the system in its current guise is the goal. Allowing a crisis to develop off the back of nationalist and populist movements would play directly into their tried and tested method of using chaos as opportunity.

Central bank communications have deliberately kept alive the possibility that monetary policy will further tighten as the actions stemming from Brexit and Trump’s presidency advance. If and when this happens, in contrast to what analysts and the public currently expect, no one can say that they were not warned.