The Powell Pivot 2.0
John Leiper – Head of Portfolio Management – 29th May 2020
In January 2019 Jerome Powell pivoted from a policy of interest rate increases and balance sheet cuts to interest rate cuts and, later that year, balance sheet expansion.
Whilst the sell-off at the end of 2018 was the catalyst for this dramatic U-turn in monetary policy, another was fear of increased tariffs on China, imposed by President Donald Trump. In effect, Trump had been using tariffs to force interest rates lower thereby conducting de-facto monetary policy.
Fast forward to this month and Trump is at it again…
For the last few years Trump has consistently called for interest rate cuts and a weaker US dollar. He sat with the top US CEOs to discuss their concerns and used the platform to accuse other countries of currency manipulation.
However, earlier this month, on Fox news, President Trump seemed to volte face, saying “it’s a great time to have a strong [US] dollar”.
It’s clear to see why Trump might want a stronger US dollar as it is consistent with a higher approval rating which is key for the presidential election in November.
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It also allows him to apply pressure on the Chinese, look presidential and benefit from the significant bipartisan support on this topic.
However, the market reaction to Trump’s call for a stronger US dollar was muted. In fact, the US dollar recently weakened to pre-crisis levels. This is consistent with our long-term house view as the surge in liquidity provided by the Fed and improving risk sentiment, as economies re-open, leads to a weaker US dollar.
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Source : Bloomberg, Tavistock Wealth
It is also possible that Trump is using the strong dollar rhetoric to force Powell into negative interest rates.
Trump has advocated for negative interest rates in the past calling them a ‘gift’ to the US economy. The idea is that negative rates would spur consumers to increase borrowing and spend or invest more money in the economy. Negative interest rates are ‘under active review’ in the UK and have been used extensively in Europe and Japan.
However, Jerome Powell recently said that negative interest rates are ‘not an appropriate policy response’. Indeed the latest Fed minutes show unanimous agreement amongst committee members against the use of negative interest rates. This is because they are highly contentious. Any positive effects are more than likely offset by a long list of negatives that include significant disruption to the banking sector, pension schemes and money markets whilst encouraging ever increasing bubbles in asset prices (notably in sovereign bonds). Looking to experience, Europe and Japan seem no better for having used them and some, such as Sweden, have even reversed course.
As shown in the chart below, Fed fund futures briefly priced-in negative rates, in early May, before reversing course later this month.
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Source : Bloomberg, Tavistock Wealth
The Powell Pivot 2.0 is a step too far and it is reassuring to see recent price action validate our current market outlook.
Our investment approach is to focus on the fundamentals, not the headlines, and as such we maintain our house view.
This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.
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