9th April 2018

Rathbones: Doomed to repeat

Jay Powell made his first speech as Chair of the US Federal Reserve (Fed) on Friday. It was a little drowned out though by a week drenched in ever-increasing tariff threats between the world’s two largest exporters.

In his speech, Mr Powell championed the monetary policy of his predecessor and set out his plan for a “patient” tightening of interest rates. He believes the US is yet to hit full employment, despite unemployment being lower than at any time since 2001. He is waiting for a sharper acceleration in wage growth to show the labour market is getting too tight before he makes any drastic decisions. Last week, US wage growth in the year to February came in at 2.7%, up 10 basis points on the previous report. The Fed’s forecast is for two more 0.25% rate hikes this year, which would take the Fed Funds rate to 2.00-2.25%.

For almost a decade, money has been cheaper than it has ever been. At the same time, assets – both financial and physical – have shot up in price and wages have stagnated in a way not seen since the Great Depression. Back in the 1930s, faced with a failing economy, the US government enacted the Smoot-Hawley tariffs and clung to the gold standard, reducing the resources Americans needed to better themselves: cheap goods and access to money.

There is a popular conceit in politics for leaders to take credit for good economic times that coincide with their term. Perhaps it’s only fair, given that when times are bad the current leader gets all the blame from voters. It’s extremely unhelpful though. The lag between policies and their effects can distort our understanding of what works and what doesn’t; of progress and regression.

In the 1930s, the world’s politicians turned their backs on the free trade and movement that propelled the previous generation’s great leaps in technology. Electricity, motorised transport and flight made the world smaller and the stars closer. The 1800s and early 1900s were no utopia – there were terrible and countless abuses of corporate power and workers. But rather than improve the system, politicians threw it out and started again. It didn’t work. Protectionism destroyed lives and generated nothing but fascism.

At the end of the day, politicians have little direct power over economies. Instead, they have the ability to adjust society by passing laws and to encourage the behaviour they think is best through tax policy and government spending. They have to create a horse by committee and then hope that the resultant camel is fit enough to carry their people forward into the future. Much of the time, these attempts immediately result in unintended consequences. Mistakes happen, but politicians should learn from the past, rather than repeat it. A tariff war between the world’s two largest economies has happened before; it didn’t end well.

Central bankers have different problems. They have a very direct effect on economies through controlling the flow of money, both through setting interest rates and by limiting commercial banks’ ability to lend. But the effects of these tools, particularly the flow of money, can take more than a year to manifest themselves.

Still, as powerful as monetary policy is, it cannot make an economy great by itself. Neither can great tax policies and laws. They are only ever the framework for a society and an economy. People with good ideas and the resources and the confidence to undertake them build what we call, bloodlessly, GDP growth. Good policies and sober monetary policy can encourage these conditions, but they can’t conjure them up by magic.

Unfortunately poor policies and monetary policy mistakes can make them disappear – and very easily indeed.


Source: FE Analytics, data sterling total return to 6 April; *to 4 April

April showers

The miserable end to winter (is it over?) hit the UK Construction PMI in March. The measure slumped to 47 from 51.4, as unseasonable snow disrupted many projects around the country. Manufacturing ticked up slightly, however, while services was also impacted by the snowy weather. Retail sales also undershot expectations. A swathe of trade figures, manufacturing production numbers and GDP estimates are due on Wednesday along with the RICS House Price Survey.

European economic data also cooled slightly, but they have had a very solid run indeed. It’s also fair to give them the same benefit of the doubt over rubbish weather that we give ourselves. The minutes of the last European Central Bank meeting will be published on Thursday.

US inflation is expected to rise 20bps to 2.4% on Wednesday, just a few hours before the release of the Fed committee minutes. Investors will be combing the anodyne text for any hint of divergence from Mr Powell’s predecessor. Finally, we’ll get the latest report on the mood of American workers on Friday. The University of Michigan Consumer Sentiment Index has been flying high recently, hitting 101.4 last month. That’s the strongest level since January 2004 and it’s expected to remain above 100 at the next release.

It’s been a gloomy few months, but economic data remains pretty good around the world. There have been a few blips recently, but there always are in the short term. Capital Economics says world GDP growth appears to have picked up a bit in the first quarter of the year. Global trade risks loom large, but there is still time for the two sides to make a deal and avert a full-scale trade war.

Investments, Investment Commentary