Rabo: The Fed Believes That Making Rich People Richer Helps Poor People Be Less Poor

By Michael Every of Rabobank

Blowin’ and Breakin’

“How many roads must a man walk down before you call him a man?” sang Dylan. Some social media is asking how many steps President Biden can walk up. The White House justified his triple slip in boarding Air Force One on it being “windy”, which is usually only an issue for plastic bags. Such snafus don’t move markets: but sadly they do matter in terms of global image projection when Great Power politics are back and the US is saying it is back too. Of course, the higher you go, the windier it gets:

#1: The US-China Alaska meeting turned into a Cold War slanging match, which finally underlined —even to the financial press— that there is no easy reconciliation to be had, even if talks continue in limited spheres. We haven’t seen a US follow-up yet, but even peacenik Japan has allowed the story to leak that its armed forces would stand by those of the US if they stand by Taiwan – a story that will infuriate Beijing. Over the weekend China sent naval vessels through Japanese waters; the Philippines is complaining 220 Chinese ships are in its maritime territory; and the Aussie ABC (their version of the BBC) is not pulling any punches – “The US and China are preparing for war — and Australia is caught in the crosshairs”;

#2: US Defence Secretary Austin sent a public message to North Korea that the US is ready to “Fight Tonight”, bellicose rhetoric that also sounds like the Trump White House;

#3: Now President Biden has publicly dubbed Russia’s President Putin a “killer”, the US is firmly opposing Germany’s Nord Stream 2 gas pipeline. The German Green party, riding high in the polls, are also opposed due to both the gas and its Russian origin – and favour a massive spending spree on a Green New Deal. This year’s election could be pivotal in determining the path for both the EU economy and for EU-US relations for years to come;

#4: Saudi Arabia says recent attacks on it from Houthi forces used Iranian weapons, and its jets have struck the Yemeni capital. Israel, where there is another election tomorrow, has also sent a signal that if it does not feel secure about a new US-Iran deal –and Iran isn’t blinking on its terms— then it could act militarily. Iran also has an election in June, which means this will bubble away until then, supporting oil prices as drivers of the headline inflation we aren’t seeing; and

#5: The EU is to proceed with a vaccine export ban to the UK, further straining relations between the divorcees, and delaying the UK’s vaccine drive by two months. The British government has already stated this will see a further shift in supply chains, as vaccine production will have to come home. There’s a lot of that rhetoric about.

Yet we can move from geopolitics back to markets and still see there is a lot blowin’ in the wind. Note the FX reaction to Turkey’s President Erdogan firing Central-bank Governor Agbal, whose brief tenure had restored credibility by raising rates by 875bp, including 200bp on 18 March. New Governor Kavcioglu reportedly shares Erdogan’s unorthodox view that high rates are the cause of inflation. We already see TRY trading at 8.16 in Asian markets vs. a close of 7.22 on Friday – and it had been as low as 8.47. Piotr Matys points out that with no FX reserves, if we see a Turkish policy easing cycle, it would be prudent to assume any matching set of measures to stabilise the currency are unlikely to be market friendly.

Markets are also still grappling with a Fed who has the theory that there is no inflation and that making rich people richer helps poor people be less poor.

Fed Chair Powell wrote a Friday op-ed in the Wall Street Journal arguing “I truly believe that we will emerge from this crisis stronger and better, as we have done so often before”, when a simple look at the 40-year trend in Fed Funds and 10-year yields says otherwise. If Powell is right, do we break that pattern?

FOMC voter Barkin just argued “We are going to see an extremely strong year, and I think that strong year is going to lead to price pressures,” but also “I want to emphasize inflation is not a one-year phenomenon, it’s a multi-year phenomenon.” Then he added “you want yields to respond to what is happening in the economy”; that in the US they reflect goods news on vaccines and the fiscal front; that “the Fed’s interest-rate dot plot is not FOMC policy”(!); and “The Fed has the tools to handle unwanted inflation.” Meaning what if not rates?

Crucially, what is the basis for the Fed presuming inflation falls back, besides base effects? *I* have one: labor vs. capital; they don’t have one – and also say they will keep pumping in capital regardless. That suggests the risk of stagflation as well as more asset-price inflation in the name of economic equality. The former threat – and any Middle East and NS2 drama– is likely to see longer US yields moving yet higher – making it a really bad time to be playing around with rates in EM.

Perhaps the perfect embodiment –with emphasis on ‘body’– of this central-bank hot air is that a New Yorker just recorded a compilation of himself and his friends breaking wind, and successfully sold it as an NFT (or digital Bitcoin-style “art”) for $85. Will we soon get a celebrity series, as we do in everything else? I can think of more than a few who would be more than willing to use flatulence to earn even more millions. Think of all the fun we could then have trying to identify whose was whose! I can also think of tens, if not hundreds, of millions of working people who would happily think of doing the same for a lot less than USD85 a pop. Indeed, would we not then need a whole new spectrum of credit analysts to sniff out the underlying value in such ‘artistry’ as potential inflation-hedge investments? And why stop there, of course? What about burps? So many new exciting disruptive market opportunities are being opened up. In short, just look at all the wealth and good jobs that are already being created as central banks try to fight geopolitical wind with wind: it sure smells like success to me!

Today we get the Fed’s Powell taking part in a BIS panel on central bank innovation. The participants will project that everything smells of roses, of course.

“Yes, and how many noses must one man have; Before he can hear people cry?” as Dylan didn’t sing.