“We’re gonna go big!” That was Joe Biden’s strapline, and that of his Treasury Secretary and former head of the Federal Reserve, Janet Yellen, at the outset of his administration only 18 months ago. They would not have had it in mind that Yellen’s successor at the Fed, Jay Powell, would want to apply the same sentiments to interest rates. Certainly not within four months of the mid-term elections.


If eyes last week were on the European Central Bank (ECB), this week the focus turned to the US Federal Reserve (Fed) and its July monetary policy meeting. Going with the form book, the Fed plumped for its second consecutive three-quarter point (0.75%) interest rate rise. As one FT commentator said, “quarter points are for wimps”. The super-hawks, albeit very much in the minority, pushing for a full-point increment even then will say the Fed bottled it to contain inflation running currently at more than four times the rate allowed for in the Fed’s mandate.

When is a recession not a recession?

The question is, is the interest rate medicine working as a cure for inflation? Constraining the money supply, containing expenditure and curbing the rate of economic activity are the essential ingredients to control inflation. As we have noted before, interest rates are not precision instruments, they are more in the way of blunt tools. What is the evidence so far that interest rates that have been pushed up from zero to 2.5% in four months are having an effect?


Second quarter economic growth data released this week points to a demonstrable slowdown as falling real earnings fail to keep pace with accelerating prices and consumers and businesses tighten their belts. US GDP shrank by 0.9% in the period compared with the first quarter, which in turn shrank 1.6% against the fourth quarter of 2021. Two consecutive quarters of economic shrinkage is the popular definition of a technical recession. However, (and here it is a case of pick your data to suit your case), those who claim that the economy is still in good shape and growing will point to the comparisons with a year ago which show that in the second quarter, growth was a positive 1.6% against the same period in 2021; in the first quarter the year-on-year growth rate was 3.5%.


Whether the economy is technically in recession or not to an extent misses the point, which is that whichever data one chooses, either way the indicators are that economic momentum is losing steam. The concern is whether continued Federal Reserve aggression really does tip the US into an unequivocal recession.

Not quite losing the ‘plot’ 

As ever with these central bank policy meetings it is not just what action that is taken, whether with interest rates or bond purchases or sales or any other inventive mechanism, as much as it is the supporting commentary which points to what happens next which matters.


And here Jay Powell, in common with Christine Lagarde’s new policy for the ECB in Europe, has determined that the Fed needs to focus more on the doing and less on the pontificating. While the ECB has abandoned ‘forward guidance’ entirely, the Fed’s newly announced approach is more nuanced, but Powell was explicit that commentary in future will not speculate on the specifics of policy. It is a feature unique to the Fed that the members of its monetary policy committee, the FOMC (Federal Open Markets Committee), make their own individual projections of where interest rates will be at different points in the future; the data is publicly available and it is known colloquially as the “Dot Plot”. As what Powell referred to as a ‘running commentary’, while not being abandoned completely, the Dot Plot in its current format will go. He will leave markets more to make up their own minds as to the appropriateness of current and future policy rather than being constantly led by the nose by the central bank.


‘Forward guidance’ was introduced essentially so that future changes in monetary policy would be well flagged: when implemented they would not be a surprise. The central banks as policy makers would always be the solution, not themselves the problem. However good in theory, central bankers became seduced in to thinking that forward guidance was the policy equivalent of Holy Writ, monetary Letters of Stone delivered from on high. What the last two years have shown as policy has been buffeted by the maelstrom of a pandemic and a major war in Europe is that in trying to hold a line on inflation (“transitory, under control, nothing to see, move on, please!”), not for the first time ‘forward guidance’ allowed them to paint themselves into a corner from which it has been very difficult to extract themselves without having to admit defeat and/or capitulate in the face of events over which they do not have control.


Does it matter? Markets will always make up their own minds, as we have seen all too clearly over the past few months with the extreme volatility in bond markets as investors and the central banks battle it out as to what is the most appropriate course of monetary policy action. By curbing or withdrawing the guidance as a reference point, it increases the likelihood of the central bank being a source of surprise, particularly in times of economic stress, with the possibility of greater volatility than normal in reaction to policy announcements, and greater speculation in the lead-up to them.

Bailey the Brave? Or Bailey the Wimp? 

Completing the monetary policy summer season, the Bank of England meets on 4th August. Will the Monetary Policy Committee ‘wimp’ it with a mere quarter-point (0.25%) rise? Or flex its muscles with something braver. Let’s see. Incidentally, and not much reported, largely because it is irrelevant in the overall scheme of things, but there is already a member of the “One Percentage Point Club”: Canada. A fortnight ago they opted for a full point rise in interest rates. As we mentioned last year, Canada, New Zealand and Sweden were well ahead of their bigger western economic cousins in recognising the then incipient inflation threat. They were employing quantitative tightening months before the Fed, the Bank of England and the ECB who at that time were still largely trying to convince us there was no problem.


Fancy! A whole article and not one mention of that man Putin. We’ll give him a rest this week.


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