The unpopular prescription

Today’s news headlines:

  • ‘Biden’s victory sets up Super Tuesday showdown with Sanders’. A comprehensive victory for Joe Biden in the South Carolina primary has given the former US Vice-President a fighting chance of beating Bernie Sanders to the Democratic Presidential nomination. The win was fuelled by the African American vote, which makes up 60% of Democratic voters in the state and is more representative of the national Democratic base. With Super Tuesday just around the corner, fellow candidate Pete Buttigieg has dropped out of the race, further boosting Biden’s campaign. (Financial Times)
  • ‘Britain to set out mandate for post-Brexit US deal’. Despite a couple of major sticking points, the UK is set to publish its objectives for trade negotiations with the US. The UK is seeking a comprehensive deal, worth billions to the country, with zero-tariff access on goods and services. Johnson’s government is resolute that public services such as the NHS need to be protected, while standards on food and animal welfare need to be maintained, both are expected to be points of contention with US representatives. The UK government will also soon set out its objectives for trade deals with Australia, Japan, and New Zealand. (Financial Times) 

Tipping their cards

Equity markets were more fearful last week than they have been in years. While there isn’t much central bankers can do to fix it, arms are being twisted. We’ve seen a collective withdrawal from markets before, but last week was different. Prompted by a virus, over which we have seemingly little control, the associated market sell-off has been relentless and widespread. Unlike the trade war issue, the coronavirus isn’t easily quantifiable in its eventual economic impact, and it isn’t a manifestation of something we control – like political will.

The further the market has fallen, the stronger the outcry for policy intervention. While there was an initial clamour for fiscal policy to spur growth, that pressure has smoothly and quietly shifted back to monetary policy. Starting with the European Central Bank, at the end of Mario Draghi’s term, central bankers have all begun sounding the call for less reliance on monetary policy, which like mythical Atlas has kept the financial firmament aloft since the financial crisis. Following a recent deeper inversion of the yield curve – a classic recession portent, when longer-dated interest rates fall below near-dated rates – the market pressure for central bankers to act has become deafening.

Overnight, the Bank of Japan announced they are willing to lend 500 Billion Yen (approx. £3.6bn) to financial firms as a result of the equity sell-off to ensure liquidity and stability in financial markets. The Reserve Bank of Australia is also set to cut rates tomorrow night – though recent bushfires were already a strong motivation. The Fed’s Chairman Jerome Powell has said the US central bank is ready to intervene as well. It seems every central banker is tipping their cards to greater monetary policy accommodation, but the market may yet be mistaken about the scope of their eventual action. Like a parent accustomed to a child’s crying, it’s possible the bank is making soothing sounds to calm tensions and doesn’t intend to provide the monetary policy dummy.

Bottom line: When things get ugly in the market, the Fed’s mandate is a problematic mission statement. The collective judgement of the Federal Open Market Committee, a nine-member decision-making body, is a nuanced assessment of the economy overlaid with a knowledge of how a prescription might affect the plumbing – in economist parlance the transmission mechanism of monetary policy. The problem arrives when this judgement must be explained in the context of the Fed’s dual mandate of steady inflation and price stability. That’s like a surgeon explaining a complex biological process to a child using puppets, but when the child only cries louder, the doctor must eventually compromise on the prescription. The Fed must support proper market function, but that’s not the same as more policy easing; puppets can’t adequately explain and communicate that nuance.

GBP/USD

The Pound fell to 2020 lows during Friday’s trading session as a consequence of the global flight to safe-haven assets. Sterling fell to its lowest against the US Dollar since October last year as investors also became more apprehensive over the impending EU-UK trade negotiations. Sterling looks vulnerable to further selling pressure while the market risk-off sentiment remains. 

GBP/EUR

Sterling has effectively lost all of its gains made in the run-up to December’s general election as it trades at the lowest level against the Euro since October. In the past week alone, the Pound has lost almost 4.0% of its value against the common currency despite a lack of Sterling-specific news. The Euro’s recent rebound has been attributed to hope that Germany will loosen its fiscal spending rules. 

EUR/USD

The currency cross continues its march higher towards the 1.11 handle, mainly due to expectations that the Federal Reserve will need to cut interest rates in the US in response to the coronavirus. Since bottoming out at 1.0778 on February 20th, the pair has rebounded almost 3.0% in a sign of a return of much-needed volatility for the pair.