A beleaguered US Federal Reserve has shown its hand by announcing another 0.25 percent interest rate increase but causing stock market turmoil and uncertainty.
Dealers had been expecting one more interest rate hike in 2019 but it seems that there will be two more (instead of the earlier feared three hikes) and the new Fed messaging was enough to send stock market prices tumbling. The Dow Jones industrial average dropped 70 points after the announcement to finish the day down 1.49 percent, while the S&P 500 lost 39.2 points, or 1.54 percent.
US stocks are on course for their biggest December decline since 1931, the depths of the 1929 Great Depression. Gulf interest rates were adjusted upward accordingly as noted in an earlier article on the likelihood of further U.S interest rate rises this year.
It was a difficult decision for Fed Chairman Powell to make , as he was under tweet attacks from President Trump and unprecedented pressure from the US President to leave rates unchanged.
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It is unusual for an American President to be so openly critical of an institution that is supposed to be politically neutral but President Trump is no ordinary American President and has waged a very public campaign against the Fed Chairman to halt further rate rises, calling the increases “crazy” and “foolish” and arguing the Fed’s policy was “the biggest threat” to the US economy, larger than the administration’s trade dispute with China.
President Trump has gone further and last month told the Washington Post he was “not even a little bit happy” with his selection of Powell to chair the Fed. On the day the Fed was meeting to make a rate decision, Trump pressed the Fed to hold off from “making another mistake”.
For the Gulf, a further round of interest rate hikes are on the cards next year and this, along with uncertainties over global economic growth and stock market upheavals, are not going to be conducive to either stable or rising oil pricesDr. Mohamed Ramady
Unlike the Indian Central Bank Governor who resigned over political pressure from Prime Minister Modi to change track, Fed Chairman Powell stood his ground.
Powell defended the Fed’s independence very firmly and said that “Political considerations play no role whatsoever” in the Fed’s decision, adding that the independence of the Fed is “essential” if the central bank is to do its job properly. Powell said the Fed based its decisions on the economic data it gathered and “nothing will cause us to deviate from that”.
There are rumours now circulating in Washington that President Trump is so furious about the latest rate hike that he is considering firing Chairman Powell, despite uncertain legal grounds to do so, with potentially disastrous consequences to stock market reaction.
Like many Central banks around the world, the US Federal Reserve has a mandate and this includes with helping to keep unemployment low and controlling inflation. The latest 0.25 percent rise comes as the US unemployment rate has dropped to levels unseen since 1969 and inflation has remained low.
However, Trump’s trade disputes and the threat of a government shutdown over funding his proposed border wall with Mexico have rattled investors, and stock markets have been highly volatile and Chairman Powell was quick to highlight these new uncertainties.
What also happens in the US stock market is one element in the decision, as Powell said the Fed was watching the recent volatility in the stock markets but downplayed their key factor and importance and added that “we follow markets really carefully but remember, from a macroeconomic standpoint, no one market is the single dominant indicator.”
A key issue is trying to forecast the strength of the American economy going forward and the Chairman spent time on this by stating that while the US economy remained strong overall, some “cross-currents” had emerged.
“Despite this robust economic backdrop and our expectation for healthy growth, we have seen developments that may signal some softening,” said Powell, signalling that the pace of rate increases may slow next year. That may explain the tone of Chairman Jerome Powell's somewhat more nervously delivered answers to the press.
On balance, if there is a tilt to Fed monetary policy stance going forward, some believe it is towards fewer rather than more rate hikes, if even for two hikes in 2019. It will depend, as Chairman Powell tried to stress, on the incoming data and how it feeds into the forecast, especially for inflation.
Analysts continue to expect that it will probably translate into a “pause” in the quarterly pace of rate hikes that is more likely to fall in the first half rather than the second half of next year.
Chairman Powell did his best to remind everyone, perhaps including his hawkish colleagues on the FOMC – Federal Open Market Committee-of the Central Bank , in repeating what must have been a half dozen times that ”there is significant uncertainty about both the path and the ultimate destination of any further rate increases.”
But he failed in the process to provide much context to what was an intended messaging about a wider variance around the base case rate path.
One suspects the somewhat muddled messaging reflected the difficulty in straddling a split within the FOMC that seemed evident in the statement: the more hawkish Committee members may have insisted the “gradual increases” language remain in the statement to signal policy is still on a tightening path.
But a compromise with the more dovish leaning members got the phrasing softened with the “some” qualifier, as well as a slightly more conditional “judges” rather than “expects” to preface the guidance.
Indeed, despite the record late cycle fiscal stimulus to demand and what Powell noted was the best year for the economy since the crisis, inflation will still come in under target this year for the seventh year in a row, and gone altogether is any of the modest overshoot previously forecast. What will happen to underlying inflation if growth and demand does indeed slow?
But Powell never did provide a satisfactory answer or explanation for that in his press meeting. What he did expand on were other international risks that Central Bank Governors have now to content with and Powell said that while US growth remained strong, globally economic growth had become more patchy and that the Fed was carefully watching “event risks” – including Brexit – for their potential impact on the US.
But he added US financial institutions are well prepared for any outcome of the UK’s exit from the EU and that the final decision should not have major implications for the US. Say that to the more confused European Union partners who are now scrambling to set up contingencies for a hard no-Bexit deal with the UK.
The U.S markets and the Fed Chairman had not expected to close the year under such uncertainties and it seemed that Chairman Powell's honeymoon period with his less detailed, easy answers to a respectful press came to an end with the December meeting.
The confusion in the markets would seem to confirm that groping in the dark barefoot is just not the optimal metaphor for Fed policy going forward. And what's more, the tweets and attacks from the White House will no doubt get worse from here. It is going to be a difficult 2019 for Chairman Powell.
For the Gulf, a further round of interest rate hikes are on the cards next year and this, along with uncertainties over global economic growth and stock market upheavals, are not going to be conducive to either stable or rising oil prices, thus putting pressure on fiscal deficits on oil producers.
Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia and co author of ‘OPEC in a Post-Shale World – Where to next?’. His latest book is on ‘Saudi Aramco 2030: Post IPO challenges’.