Monetary Policy Versus Markets, Eurozone Growth Anxieties, The U.S. Government Shutdown: Month 2

  • Monetary Policy Versus Markets
  • Eurozone Growth Anxieties
  • The U.S. Government Shutdown: Month 2
  • Even the best parent/child relationships have rough patches. The parent has to balance roles as the child’s #1 supporter and as the family’s Chief Reality Officer. Growing children need their parents for support, but also crave the freedom to make their own way. Some periodic friction is par for the course.

    Less common are situations where the two roles become blurred. When lines of authority aren’t clear, it becomes much more difficult to reach a resolution. Careful communication between parties is required to sustain coordination.

    Central banks and financial markets are very closely related. When they are in synch, both perform well. When they are not, outcomes suffer and arguments arise over who is the ultimate authority. As we settle into 2019, the dynamic between markets and monetary authorities will be critical to performance.

    This is going to be a difficult year for central banks. The economic outlook has become much less certain, with China looking particularly shaky. Traditional links between growth, employment and inflation are fraying, diminishing the value of frameworks used to calibrate monetary policy. There is no roadmap for unwinding quantitative easing (QE). Trade policy is at a crossroads, and politicians around the world are questioning central bank independence.

    Amid these challenging circumstances, the Federal Reserve struggled during the fourth quarter. The Fed seemed slow to appreciate down-side risks to economic growth, and sent conflicting messages about its intentions. Fear of a Fed overreaction was among the reasons cited for the recent correction in world equity markets.

    The Fed has been slowly normalizing conditions since the end of 2015, calibrating each step carefully. Interest rates remain very low by historical standards, but are approaching their long-run “neutral” levels. The Fed’s most recent projections call for more hikes, which would take rates into restrictive territory.

    To the markets, this was tone-deaf. While the Fed’s forecast (and almost all private forecasts) calls for continued growth, threats to the expansion are accumulating. And inflation remains remarkably calm, even though unemployment is near a 50-year low. A pause to assess seemed warranted.