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Shortly after indicating that further gradual rate increases were on the horizon, the US Federal Reserve made a mysterious U-turn and reported that its bullish cycle was over for now. This disturbing decision has led many people to think that it was an answer to the alarm signals regarding the US economy.
Without doubt, the global economy has slowed down. But the various measures of US economic performance are almost universally strong. The latest ISM survey on the manufacturing industry rebounded in a smart way, indicating solid growth; retail sales remained strong; inflation is close to the Fed's 2% target; and the latest jobs report shows a considerable increase in the wage bill, far exceeding consensus expectations.
The US economy is in poor health: fears of recession have been and are exaggerated. Fed Chairman Jay Powell discussed factors such as slowing global growth, tighter financial conditions and geopolitical issues. However, the world is more positive from three points of view: the stimulus measures put in place since last June should ultimately stabilize the Chinese economy in the second half of the year; the Bloomberg US Financial Conditions index is at its highest level in nearly three months; and negotiations between the United States and China are under way.
It seems more credible that the Fed's decision is based on two factors. First, the slow pace of the job market. The January employment report found that strong economic growth continued to push workers into the labor market, leading to higher participation rates and limited wage growth. It is almost inconceivable that the labor market is still functioning at full capacity.
Secondly, a capitulation on the markets; Investors have always been talking about "Fed policy", relying on the central bank to support equities by focusing on easier money in difficult times.
There is method to the madness of these. Market crises can feed as confidence begins to collapse – a self-fulfilling collapse of the market. If financial conditions deteriorate significantly, a negative market performance could weigh heavily on business investment intentions and consumer confidence. This script seemed to be played in December. Investors seemed to understand the idea that a recession was to be feared precisely because the stock market was down. While the market has stumbled, the sentiment of business leaders has also dropped.
In December, in the Duke CFO Global Business Outlook survey, nearly half of those polled thought the US would be in a recession by the end of 2019, with 82% anticipating a fall before the end of 2020. were preparing for a recession and began striving to create the conditions for a mild recession. Financial markets could be not only a leading indicator of the recession, but also an engine.
We exist in an ideal climate so that the next slowdown is the result of a collapse of trust. At the time of the previous financial crisis, there were about 300,000 tweets a day; Ten years later, there is more than this number in one minute, or more than half a billion a day. The echo chamber intended to amplify the anxiety of the market has never been so great.
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The risks are important. US corporate debt has reached unprecedented highs. a further deterioration of financial conditions could have quickly resulted in a sharp increase in business failures, with obvious negative repercussions on the economy as a whole.
By removing concerns about excessive policy tightening, the Fed has avoided this scenario – for now. He released "animal spirits", greatly reducing the risk of a short-term self-fulfilling fusion. It is difficult tactically to be a short risk badet. Robust growth and a patient Fed is certainly a good mix.
However, the upturn through the equity and credit markets raises fears that the Fed's short-term support for an already healthy economy opens the door to a surge in volatility later in the year. A strong recovery in growth here is certainly not desirable.
If employment gains continue, the labor market will eventually reach full employment. Higher operating and labor costs would follow, leading to higher inflation. Inevitably, the Fed should reverse its recent vision. But while patiently waiting for stronger inflation to materialize before resuming action, Powell also disputes the widely accepted view that policy rates are lagging behind.
The Fed would be on the back foot, compelling it to catch up by pressing the brakes. Reacting late to an increase in inflation can be just as damaging as acting prematurely. It may not be easy for the Fed to resume its rate hikes without risking a further collapse of confidence, which would once again drive the markets to a standstill. The stock market recovery may have been prolonged, but the risk appetite may be questioned. If the risk of recession in 2019 is lower than it was two weeks ago, the risk of recession in 2020 has certainly now increased.
The aphorism that "expansions do not die of old age, they are murdered by central bankers" was written during times like these. Enjoy the risk race while you can.
Seema Shah is Senior Global Investment Strategist at Principal Global Investors
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