The Federal Reserve had planned for years its exit strategy, its way out of the unprecedented support it had provided the global economy. Now, as it embarks upon its plan in earnest, everything is getting turned around.
The Fed’s been planning its exit strategy since at least May 2013, when Ben Bernanke first mentioned it. Implementing the plan would fall to Janet Yellen, the current chairman. She has telegraphed the bank’s moves, and has taken the steps slowly and steadily. First, shut down QE3 (October 2014). Then, raise rates, just a bit (December 2015). It’s glacially slow, but it is moving in the direction of “normalization.”
The problem right now is that absolutely nothing is cooperating. Consider the following:
– The other central banks are running in the other direction, embracing the risky, unproven strategy of negative interest rates. The ECB went there first, and the Bank of Japan followed. The idea was that negative rates would be a strong spur for bank lending, as well as devalue the currency. “It won’t work,” former St. Louis Fed president William Poole wrote in the Journal, calling them a dead end. “Negative central-bank interest rates will not create growth,” he said, “and it will divert attention from the structural problems that have plagued growth here.” In other words, it will make “normalization” even harder.
– Speaking of plague-ridden growth: After this morning’s report on wholesale inventories implied higher than expected inventories (even though they were down), first-quarter GDP growth is looking even weaker than the fourth quarter. Marcoeconomic Advisors sees first-quarter GDP at just 0.4%, with 2016 tracking at 1.9%. Barclays now pegs first-quarter GDP at just 0.3%. At that rate, a stiff wind could push the economy into recession, which is why you’re hearing that word more often these days.
– We don’t need to tell you that the markets are also going against the Fed, do we? U.S. equities, which had been widely viewed as the proverbial “only game in town” for yield-seekers, have been getting routinely battered. The S&P 500′s Tuesday low at 1835 is below the index’s closing level of 1848 on Dec. 31, 2013. More than two years wiped out. Meanwhile, the dollar has strengthened and oil prices have crumbled, which has threatened to unwind the entire capital markets. How do you normalize amid all this?
Which brings us to Wednesday, Ms. Yellen, and Congress. The market is already betting, heavily, that the Fed will back off its implied course of raising rates four time this year. Now, traders will want to hear Ms. Yellen say it. “If Yellen persists in leaving the door open for monetary tightening later this year, financial markets could react even more negatively,” noted Deutsche Bank ‘s chief U.S. economist, Joseph LaVorgna. He doesn’t expect her to “completely back away” and thinks the bank is not at all sold on the benefits of negative rates.
That, he said, leaves the Fed “between a hike and a hard place.”