The World Beyond the Fed
Fed latest: Jay is taking bigger steps but not jaywalking in Wall St.
Climate Change: the day before yesterday
Pandemic legacy: the day after tomorrow
Figure 1 Taper sorted, next up rates?
Source: Daily Shot/FOMC ‘Dot Plot’
Fed latest: Jay is taking bigger steps but not jaywalking in Wall St.
You have got to hand it to Fed Chair Jay Powell. Many say he panders to Wall Street but he is proving remarkably able to soothe its more nervous ‘roadies’ as he tries to turn the corner on monetary policy. First, he persuaded the market to separate in theory tapering asset purchases from hiking official interest rates. Then in August, he signalled that in practice tapering would start soon. Now he has more or less fixed mid-2022 as the date to stop QE altogether, which is sooner than the market expected. Also unexpected were changes in the ‘dot plot’ pointing to a rate hike in Q4 next year and 6 in total by the end of 2024. As this would still keep official rates below 1%, Mr Powell has again avoided being run over by panicking sellers. The main response so far from more serious investors has been to push bond yields modestly higher. In contrast, US equity markets saw another bout of the mindless ‘buy the dip’.
For those who care to look, the Fed is not expecting a lot of economic growth in the US or globally andthe Fed and other major central banks are expecting growth to slow and inflation to run ahead for longer. They are, of course, avoiding using the dread word ‘stagflation’, which for them would be an admission of defeat. To be fair, although the central bankers are the architects of some of their current challenges (notably a liquidity flood, asset price bubbles and excessive private sector debt) they cannot be blamed for the two most important ones. Climate Change and the pandemic are already casting economic shadows that record US equity prices suggest are still being largely ignored or wished away, despite warnings from the Fed and others (notably Mark Carney). Fortunately, meeting these two challenges requires human creativity and altruism that transcend markets and monetary policy.
Chart 2 Climate change is already here
Climate Change: the day before yesterday
This is not the place to describe or still less to forecast climatic changes but it is necessary to accept the over-riding conclusion of the latest IPCC Report (Chart 2) that the long-term need for action has skipped over the short-term stage to become immediate. Fortunately, there are almost daily signs that public officials around the world are stepping up the planning and implementing of a wide range of macro and micro policies. It is also seems that concerns of the younger generation (bravely fronted by Greta Thunberg and her many supporters) are increasingly shared by older generations, which in turn obliges political leaders to pay ever more attention. Of course, there are national politicians who are still stuck in a ‘doom loop’ of prioritising economic growth in order to get votes but at the expense of the planet. Elsewhere, especially in the advanced economies Green Parties are increasing their representation or, as in Canada, having other parties pinch their policies.
At the UN General Assembly Boris Johnson urged the international community ‘to grow up’ and face its responsibilities, including cutting down on gas consumption. Fear of irony (Chart 3) as usual did not prevail over Mr Johnson’s fondness for an amusing turn of phrase but, while not (yet?) admitting to a Damascene Conversion, he is clearly treating COP26 with as much seriousness as he is capable of. The UK is lobbying for the Conference to agree to the ending of coal consumption in advanced countries by 2030 andin developing countries by 2040, for the phasing out of carbon fuel vehicles by no later than 2035, for the banning of deforestation by 2030 and for annual aid of $100bn to help developing countries comply with these targets. President Biden has expressed support, including upping the US aid contribution while President Xi has joined South Korea and Japan in ending overseas coal-fired projects (China will still pursue new domestic projects for the time being).
Chart 3 Going green has costs and consequences
It is seems a relentless and necessary momentum is building that will bring fundamental changes for all of us, such as where we live and work, how we get about and what we consume. Rising sea levels, flash flooding, wildfires and limited water supplies will determine inhabitable locations. Carbon emission rationing will determine the design, construction and maintenance of new buildings and the refitting of existing ones. Commuting, car usage and business and holiday travel will become subject to some form of restriction, voluntary or otherwise. Recycling will become more strictly enforced, especial food waste and toxic materials. The Farming sector will be expected to reduce methane emissions and use new organic fertilizers, which means supermarkets and caterers will have to adapt their meat offerings. Manufacturing is likely to be more localised to reduce transportation and require new product designs, new machinery, reduced raw material consumption and carbon emissions. It has started!
The list of inevitable changes is almost infinite and they are likely to become increasingly unpopular in the next few years. Unprecedented investment, public and private, will be required but even that may not make up for the reduction in consumption caused by higher prices, interest rates and taxes, together with new regulations and restrictions. It is likely that at least for the first transitional years most people will be somewhat worse off and that global output will fall (something that is clearly weighing on the Fed’s decisions). There will be much finger-pointing within and between families, communities and countries. As usual, the worst affected will be the less well-off families and poorer countries, which will require even more intervention and co-operation by governments. However, it would surely be wrong to despair. Only a very political leaders, whether democratically elected or otherwise, have no regard for the welfare of their people and with Climate Change it is more a question of survival. Some will take longer than others to adoptwhole-heartedly the measures that their scientific advisers and officials are bringing forward. Meanwhile, the best businesses are not waiting for the politicians to catch on but it seems others are paying only lip service or are just floundering. Record equity prices are also distracting investors from being more discriminating. The adage that ‘necessity is the mother of invention’ is surely going to put to the test over the next decade in a way that will make previous industrial revolutions seem more like gentle and genteel evolutions.
Chart 4 What is normal, anyway?
Pandemic legacy: the day after tomorrow
The COVID-19 pandemic (and future pandemics) is the other urgent challenge for humanity, perhaps ultimately less lethal than Climate Change but it does raise many similar issues. In fact, the pandemic has already hit GDP growth hard and reignited inflation after many years. Even if these outcomes turn out to be ‘transitory’ in part, they provide insights into the probable economic consequences of Climate Change. In basic economic terms, there has been a Demand Shock caused by the lockdowns and other restrictions that has been significantly ameliorated by government financial support for individuals and businesses. This has in turn prompted multiple Supply Shocks around the world, which has meant the recovery of Demand has exceeded Supply thereby sparking a series of price rises that have combined to send Consumer Inflation to levels not seen for decades. Needless to say, other factors are at work in different parts of the world but it seems that the Fed and other central banks have realised that they may need to restrict inflationary pressures despite their misgivings over growth and unemployment.
Chart 5 is a useful checklist of social and economic developments arising from Covid-19. The referenceto Sun Belt states could apply to only the most popular destinations of Texas and Florida but could equally well include all the Southern states from the East to the West Coast, all of which are notoriously heavy consumers of energy and water. CBD stands for Central Business Districts, which typically include or adjoin areas with high population density. The Federal deficit refers to the surge in public spending to mitigate the worst effects of the pandemic. The terminology may have a particular US resonance but it seems clear that Covid-19 is having a similar impact in all other developed economies and many developing countries. Of note, is that many of the developments were already underway before Covid-19 struck and will need to be stepped up as Climate Change measures, irrespective of when the pandemic recedes. There is a clear continuity between the day before yesterday and the day after tomorrow.
Figure 5 COVID-19’s impact on key trends
Nevertheless, the issue for today is that Covid-19 is still very much with us. Very few governments seem to have been able to balance containing its spread among the population and minimising its disruption of the economy and the health and other public services. After their early successes in containment, China and Vietnam are now struggling with restrictions and economic slowdowns. New Zealand is one of the few countries still seeking complete eradication and has paid a high economic cost and yet is still experiencing localised outbreaks. Italy, which has been able to make economic progress on the back of a very high level of compliance with mask-wearing, is going one step further in requiring all employees in both public and private sectors to be vaccinated in order to go to work between 11th October and 31st December. In contrast, Denmark and Norway have lifted all restrictions for the time being while both their economies have recovered from their slump in 2020.
Looking around the world it is still impossible to determine the best mix of policies. If mortality as a proportion of overall population is one measure, then Latin American countries are faring the worst, followed by the US, UK and France, with Asian countries reporting fewer deaths. In terms of GDP growth, Taiwan, China and Vietnam are still ahead but the US is now back in positive territory (Chart 4). Vaccinations do appear to reduce infection, hospitalisation and death rates, which puts Western European countries ahead of the UK, US and China while many poorer countries have yet to get scale up (Chart 6).
Figure 6 Progress but what levels can poorer countries eventually achieve?
It has to be said that many of the measures to ameliorate are proving widely unpopular and even divisive despite the evidence of hospitals’ delaying treatment for other conditions in order to cope with Covid-19 patients. It appears that ‘anti-vax’ is becoming politicised with moves in Florida to restrict vaccinations for other diseases such as measles. Resistance to the Covid-19 jabs in some richer countries is higher among ethnic minorities and in many poorer countries to the extent that Bill Gates believes that by next year the supply of vaccines will exceed demand. This is bound to hamper a return to normality, however that is defined, all around the globe and would represent a cruel legacy that could undermine efforts to cope with future pandemics. This, rather than the taper, will surely be the big story next year, together with COP 26.
Disclaimer: This report is compiled from sources the author believes to have been reliable but it may not be complete or accurate on any particular subject. All opinions, estimates, and analyses are or were those of the author at the date of issue and are subject to change without notice. Accordingly, the author makes no representation or warranty on any subject discussed in the report; nor does he accept responsibility or liability for any claim, loss, damage, expense or cost arising from reliance upon its contents.