Friday, 21 June 2013

Bernanke Vernacular

Ben Bernanke the Chairman of the Federal Reserve Bank has been on quite a journey since 2007, having saved the world after the Lehman's default he has nursed the US economy back to health quicker than anyone would have dared to hope.  The soon to be retiring Chairman of the Fed  warned us this week that over the next year he would start tapering off the amount of money the Fed pours into quantitative easing, which is currently running at $85bn a month.  This effectively signals the end of ‘near zero’ interest rates in the US and around the world. 

The bad news for the rest of us is that we are all travelling behind the US in the economic cycle.  This means that our more fragile economies, in dire need of low interest rates, will be caught on the rising tide of interest rates unless we choose to devalue our currencies.  The emerging markets that are now moving into a ‘lower growth’ cycle will be most affected and in sympathy the Shibor overnight lending rate in Shanghai spiked violently to 29pc this Wednesday.  Officials in China noted that “We cannot use a fast money supply growth as in the past…. to promote economic growth.” Some commentators believe the world economy is now facing a “perfect storm” as the Fed prepares to taper its bond purchases (QE) at the same time as worldwide dollar liquidity tightens.   This will have the effect of penalising commodity exporters and other dollar reliant economies.   The main worry is China where credit (borrowing) has jumped from $9 trillion to $23 trillion over the past five years, exploding from 125pc to 200pc of GDP.  Imagine the impact of sharply high interest rates on this market.
Whilst there may be threats abroad Bernanke thinks that the US economy has navigated the fiscal tightening better than expected and the risks surrounding the euro have abated he did however go to great lengths to mitigate the pugnacious overtones of this message in several respects. The asset purchase programme (QE) will finish only when the US unemployment rate has fallen to 7 per cent or below, which the central bank expects to happen by mid-2014. Bernanke said that in the meantime, the pace of asset purchases could be increased as well as reduced, depending current data.  The chairman also emphasised that the date of the first rise in the interest rates would follow sometime after QE3 ends. The 6.5 per cent unemployment threshold required for this to occur (increased interest rates) was certainly not to be viewed as an automatic trigger, and there were hints that this figure could be reduced further.  So we will all have to watch the employment numbers in the US with baited breath. The employment/population ratio, which is Gavyn Davies, preferred measure for the state of the labour market, is still flatlining, so it may well be a longer wait than everyone thinks.
The 'good news' on US employment number maybe an illusion -thanks to Gavyn Davies' FT blog

If the Fed viewed the labour market as a major problem late last year, it is not clear why it should have changed its minds since then.  With all the attention of worklessness what about inflationary pressure – after all this is the key metric for any Central Banker.  Well, the consensus view on inflationary pressure is still very benign and if the bond markets see further fall out we can expect to see import prices add to this deflationary pressure. Actually what Bernanke said on inflation was -
The economy is expected to improve and unemployment come down faster than I previously thought, but inflation is also expected to be lower this year than our earlier forecasts despite this improvement. But not to worry: inflation should bounce back in the direction of 2 per cent by next year, as its current downward trend is likely the result of specific temporary factors, even if to everyone else it seems broad-based. But if it doesn’t, or if unemployment doesn’t come down as I expect, I’ll take that into account in deciding when to start and how fast to taper. And by the way, my colleagues on the FOMC are leaning towards a later start date for the first rate rise, which seems to contradict the more-optimistic outlook. Two possible reasons, in case you’re still following, are that we don’t necessarily trust the unemployment rate and that we’re actually a bit more worried about disinflationary pressures than we let on.
God! The tortuous language of Central bankers really is bewildering, but understandable as the stakes are very high.  The main problem of unwinding from negative real interest rates and major scale asset purchasing programmes is caused by the law of unintended consequences.  One of the main consequence of QE and low interest rates in the West has been a great boom in the emerging nations of the world as investors seeking, higher yields (than available at home), have been forced into riskier markets, this has been supported by credit easing, as discussed earlier, and we now have a real threat that the tables will be turned.  In 2008 -2010 the world economy was partly saved by the strength of economic activity in China and other emerging markets.  Now as the West is starting to see the first green shoots of recovery these emerging markets threaten to bring the whole structure crashing down.  So the language couldn’t be more important.  Ben Bernanke needs to be scary enough to take the froth off these more risky markets, whilst not pushing the BRIC economies into recession.  And of course the real fly in the ointment is Europe – still saddled with alarming levels of debt and under capitalised banks the last thing the Eurozone need is rising bond prices and higher interest rates. 

Bernanke is no fool and has done an amazing job to date, but whether he can navigate the last stretch of this terrifying journey remains to be seen – we should all be wishing him the very best of luck.

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