Central bank governors and OPEC chiefs have the same predicament – how to put out their message or narrative out without giving too much way and yet try to steer markets in the direction they want without spooking traders. If the new US. Federal Reserve Chairman Jerome Powell wanted the markets to take his maiden Semi-Annual testimony before the House Financial Services Committee yesterday as a first foray towards four rate hikes this year, he got what he was looking for, and then some. More specifically, Chairman Powell's "personal outlook" reply to the question about the March quarterly Summary of Economic Projections – a listing of a virtual cocktail recipe for an overheating economy -- sounded so jarringly bullish, if not outright hawkish that it leapt out from the otherwise more balanced remarks in the rest of the Q&A and the written testimony.
At minimum, it felt like a first small step towards a four hike path, and whether intended or not, Chairman Powell in that one response put a four hike market pricing just one or two stronger than expected data points away. The markets reacted by selling stocks and it took Powell the next day to resort to yet a more nuanced clarification to stave another sell off. Allaying fears that could have led to a new global banking contagion, according to Powell, the US banking system was "healthy", and that banks “ are better able to manage risk and failure. It's a good time in our system," he told the Senate Banking Committee. He also calmed fears that the pace of interest rate rises would accelerate. “There is no evidence the economy is overheating," Powell said. Although the current 4.1% unemployment rate was "at or near or even below" estimates of the full employment rate, "we don't see any evidence of a decisive move up in wages... Nothing in that suggests to me that wage inflation is at a point of acceleration." And so there it was – these new narratives saw Wall Street's main indexes overturn earlier losses to trade higher and eased some of the fears of faster interest rate hikes stoked by Powell's comments earlier this week about a strengthening US economy in his first appearance in Congress on Tuesday.
Market analysts will be somewhat cautious that the Fed will be moving too soon to a four rate hike scenario, preferring to see how inflation, and perhaps an early indication of investment spending look to be playing out this spring before signalling a fourth rate hike. That would put any upgrade in the pace of hikes this year more likely still into the June meeting. While the markets after an initial shock sell-off seem to have taken it in stride, we suspect a rates messaging that feels pre-emptive could nevertheless strain the Fed's ability to control its gradualist messaging if his remark is left alone The market, for instance, could go on alert for an even more hawkish Fed, pricing beyond four on every data point that comes in a bit stronger than expected in the months ahead. That could especially prove to be the case if the inflation prints show, as expected, an uptick this spring when last year's "transitory" downward pressures drop out of the year-on-year data.
The main question for those waiting to see when to borrow is that despite all the upbeat data that we see coming out of the US, the main concern is going to be the pace of these rate hikes and how quickly is it going to happen.Dr. Mohamed A. Ramady
A delicate balancing act
The US Fed will want to be a bit more cautious in the sequencing of its rates messaging, if that is the right way to describe it, as it is far easier transmission into the markets to modestly upgrade the economic and rates outlook as the data come in than it is go too soon to a more hawkish stance and then backpedal if the data should even modestly disappoint. It will, in any case, be a delicate messaging balancing act for the new Chairman in the next few months. US Fed officials are painfully aware that the balance they are seeking in the policy path between an overheating economy and nudging inflation up to mandate-consistent levels crucially first requires an equal balance in their policy signals. Ensuring a smooth transmission of the intended monetary policy into the real economy while at the same time containing speculative or excess reactions in the financial economy that could slow the economy's solid momentum too soon by too much could prove to be no mean feat. The same applies to those trying to ensure that oil prices are nudged to what is an acceptable level for the current OPEC and non OPEC producers, without "over heating" prices if stocks continue to rebalance much faster than anticipated, and once again inducing non participating oil producers to come in and redress balances and drive prices unintentionally down, thus going back to square one.
What the US Chairman says or does not say affects us all and both US and European bond yields - investments in fixed income as opposed to equities - have soared in recent months amid speculation that the Fed’s monetary policy will be tightened at a faster pace. But in the equity markets that possibility is increasingly testing nerves, as traders try to divine how many increases are coming. In the Gulf, these 3 or 4 expected rate increases could only lead to further interest rate hikes and domestic inflationary impulses affecting cost and productivity. The main question for those waiting to see when to borrow is that despite all the upbeat data that we see coming out of the US, the main concern is going to be the pace of these rate hikes and how quickly is it going to happen. At least though you have been warned as the narrative is out there for all to see but leaving each with his or her own take -away message of that given narrative.
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.’