Coming from the other side of the Atlantic, an audible anguished moan of pain followed by an immediate screeching of tyres. They represent the severely twisted arm and a sharp hand-brake turn resulting from the casual carjacking of a central banker and his policy by his President.


Jerome Powell has been appointed for a second term to Chairmanship of the Federal Reserve (Fed) but he has been politically nobbled in the process. Facing the mid-term elections next November and vulnerable to his administration becoming a lame duck, President Biden clearly made it a condition of Powell’s continuation in office that the Fed should urgently give its undivided attention to the need to contain soaring inflation.


We have referred many times in these musings to the Fed’s apparently dilatory and dithering approach to monetary policy as Powell tried to reassure markets that inflation was transitory, it’ll sort itself out in time. But time is not on Biden’s side and the extent to which Powell has been forced to reappraise the situation was only too evident in his speech of thanks to Biden for being re-nominated (his appointment must now be confirmed by votes in both the House and the Senate). It is worth quoting the relevant passage in full:


“Challenges and opportunities remain, as always. The unprecedented reopening of the economy, along with the continuing effects of the pandemic, led to supply and demand imbalances, bottlenecks, and a burst of inflation. We know that high inflation takes a toll on families, especially those less able to meet the higher costs of essentials like food, housing, and transportation. We will use our tools both to support the economy and a strong labour market, and to prevent higher inflation from becoming entrenched”.


Every vestigial reference to inflation as a transitory phenomenon has been expunged. Interesting too are his references to food and transportation, the inference of which includes gasoline prices: when assessing interest rates in the context of the 2% inflation target, the Fed uses Core PCE (Core Personal Consumption Expenditures prices) as their preferred measure instead of the more conventional CPI (Consumer Price Inflation). Core PCE explicitly excludes food and fuel prices because of their volatility, notwithstanding that families still need to eat and drive whether food and fuel prices are rising or falling (in reality there is very little price elasticity of demand for either); Powell’s is a tacit admission that PCE is a cop-out; CPI is much more reflective of real life inflationary pressures than PCE.


Powell will be joined by newly promoted Lael Brainard as Fed vice chair. Powell, a Republican originally appointed by Trump, was likely to have seen his reappointment opposed in the Senate by left-wingers including Elizabeth Warren and Bernie Sanders. While refusing to be pigeon-holed, Brainard is demonstrably leftward leaning economically and politically, particularly favouring much tighter regulation and intervention by the state in sectors such as banking and finance; a sop to the left, Biden is using Brainard as a political hedge to ensure Powell is returned unopposed. Hers and Powell’s may not be the easiest of partnerships on a board which still has several open seats to be filled, but Brainard too was explicit in her own “thank you, Mr President” speech that tackling inflation is her top priority.


The question is what does the Fed do now? It has already begun decelerating its bond purchasing programme which until October was running at $120bn per month, is currently $105bn and will fall to $90bn a month from December. Do not confuse this with quantitative tightening (QT); all it represents is a modestly slower rate of piling on the coals. Higher interest rates are needed to tackle inflation but before rates can rise from zero, a pre-requisite is that money printing must cease entirely: no net new liquidity, no re-financing bonds which have reached maturity. A real commitment to QT would see the Fed actively shifting bonds off its balance sheet back to the market, but perhaps that is a step too far.


Central banks’ triple witching hour

Quantitative tightening has already begun with Sweden, Canada and New Zealand having not only stopped their bond purchasing programmes but also begun raising interest rates. But with all due respect to those noble countries, the reality is they are bit-part players on the global economic stage. Among the western democracies, the leads are the US and the eurozone, such is the extent of their reach and influence as the principal reserve currencies. Some would argue the toss about the relevance of the UK, but London remains a key conduit of capital financing: call it a cameo appearance.


The two days spanning December 15/16 are the next key dates for central bank watchers, almost a triple witching hour as the monetary policy committees of the Fed (15th), the European Central Bank (ECB) and the Bank of England (both on the 16th) meet. With US CPI now tracking at over 6%, political pressure being applied by the White House and both Powell and Brainard declaring inflation as Public Enemy No 1, then not to give markets some idea of what concrete measures are likely to be taken would seem to be not an option.


Meanwhile here, with the Bank of England governor Andrew Bailey having already been branded an “unreliable boyfriend” after ‘talking-the-talk’ of the need for higher interest rates and then promptly failing to ‘walk-the-walk’ at the November MPC meeting, expectations are high that in December the MPC will finally vote to increase base rates by 0.15% points. The Bank is already ahead of the Fed in having announced that effective December, quantitative easing will have stopped.


Will the ECB be left pursuing a divergent path? Christine Lagarde has been the most strident of the three central bankers on the “nothing to see, all is well, please move along!” tack about the transitory nature of inflation. Her policy committee has been constrained by politics: with the EU’s €750bn covid recovery war chest only having started disbursing funds at the end of July, and now finding much of the EU mired in yet another wave of a resurgent virus and lockdowns and curtailments of freedoms being the order of the day, would now be an acceptable time to be weakening the resolve to provide economic support, regardless of the underlying inflation pressures evident across the eurozone and the yawning chasm of a negative real interest rate? Time will tell.


When you’re in a Hole…

It is well recognised among military strategists that one of the most difficult things to pull off successfully is a fighting retreat when fully engaged with the enemy. Yet that is precisely the position in which the central banks find themselves. Or another way, through the blinkered dogmatism of their forward guidance, and particularly that of the Fed which even as recently as six months ago was preaching that it expected US interest rates to remain unchanged as far out as 2024, they have dug a great big hole from which they now need to extricate themselves while trying to limit the damage to their credibility.


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The value of active minds – independent thinking

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Fund specific risks

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