Highlights
• Central banks proceed with caution on policy changes
• World watches and waits amid trade tariff threats
• Fed determined to normalize interest rates
There is an old saying that “all roads lead to Rome,” which literally means that during the time of the Roman Empire every road led to the imperial capital city. Transformed by history, the expression has been generalized to mean that all roads, all paths and activities, radiate from the center of things.
In the world of global markets, the last nine years have been governed, for the most part, by central banks, and by central bank financial largesse, commonly called liquidity or accommodation. Trillions of dollars have been injected into sovereign debt, corporate debt, mortgage-backed assets and even ETFs, to jump-start global growth. With interest rates near zero and lower, the global economy has been lifted out of stagnation, and with fiscal stimulus introduced in the United States, estimates for U.S. growth continue to be upgraded.
Although the “synchronized global recovery” that characterized the world’s economy last year has been modified, the European Central Bank (ECB) and the Federal Reserve have begun the difficult task of moving monetary policy toward a path commensurate with healthy economies.
The goal is to adjust policy without thwarting the recovery that was so stubborn in developing, and to bring rates to a neutral or equilibrium level that neither stimulates the economy nor hinders it. And while the Fed has assured markets that the path toward rate normalization will continue to be gradual, the ECB has issued a clear timeline of slowing and ending bond purchases, followed by a pause, and rate increases not beginning until the summer of 2019. Meanwhile, the Bank of Japan (BOJ) will continue its quantitative easing, or bond-buying program, as it strives for inflation to reach the seemingly elusive 2 percent level, a level associated with “healthy” inflation.
Although the Federal Reserve appears determined to raise rates again in September, and perhaps in December, there are obstacles that may deter a more hawkish approach. Clearly, the Fed would like to take advantage of still-favorable global financial conditions, but as Federal Reserve Chairman Jerome Powell noted at the press conference following the June FOMC (Federal Open Market Committee) meeting, the Fed can move in either direction depending on the situation. Still, the ability to add more basis points to the Fed’s tool kit will allow the FOMC to use conventional monetary policy rather than relying on the unconventional policies introduced during the downturn. The prevailing question for markets is whether the economy can withstand the tightening, albeit gradual, following nine years of ultra-low rates and a market coddled by central bankers who refused to let markets slide and adjust on their own in what used to be considered normal market behavior.
William McChesney Martin Jr., who served as Fed chairman for 19 years (April 2, 1951 –January 31, 1970), once said the primary role of the Fed was to “take away the punch bowl just when the party gets going.” The tug-of-war in both the equity and Treasury markets centers on a crucial question regarding the very strength of the party.