Tuesday will offer clues if the Fed’s new chairman is really about to clone the dovish policies of his predecessor

Leadership change at the Federal Reserve will come into focus this week as new Chairman Jerome Powell addresses Congress for the first time

PUBLISHED : Monday, 26 February, 2018, 10:19am
UPDATED : Monday, 26 February, 2018, 10:43pm

Global markets have wallowed in a once-in-a-lifetime experience of ultra-cheap money and they should enjoy it while it lasts. For the most part, it has been a white knuckle ride, emerging from the dark days of the financial crash 10 years ago, into the bright light of super-stimulus and free-rolling, one-way bets in a seemingly never-ending rally. Who would want it to end?

Now comes the tough part, the snap back to reality as the markets come to terms with living in the real world of less stellar recovery, rising inflation risks and a less palatable policy environment. It is a normality shock. Policymakers are keen to wean the world off monetary steroids as soon as they can to ensure the wake-up call is as smooth as possible and a hard landing avoided.

Global policymakers know they went well over the top to rescue the world economy from deeper rot and the time for recall is long overdue. Global growth has settled into a reasonable pace, the appetite for risk looks overstretched and investors must be let down gently. Jumping into zero interest rates and quantitative easing was kids’ stuff compared to the challenges ahead.

So it is no surprise markets are getting jumpy about succession risks in two of the biggest pro-activist nations behind the great monetary experiment. The US and the euro zone central banks have plied the markets with so much cheap money it is a big worry when the script changes with key personnel changes coming at the top. Markets gorged on so much generosity should be concerned.

Future interest rate intentions are crucial and make a great deal of difference to relative bets between US and European fixed income, equity and currency markets. Any hint of policy re-jigging will have a major impact on relative perceptions and investment flows between the two markets.

In the US, the policy baton has already passed from former Fed Chairwoman Janet Yellen to her successor Jerome Powell, but markets need to know the measure of the man when he gives his first testimony to Congress this week. It is no coincidence markets have been hesitant ahead of his recent swearing-in. Markets hate uncertainty and a new Fed governor is a big deal.

Powell will want to avoid creating waves early on, but will be keen to lay down his own marker as soon as possible. The big question is whether he is as committed to propping up markets in times of crisis as his recent predecessors were with the euphemistically named Fed put option – the unspoken guarantee the central bank would always intervene to ensure market stability.

This has always been a comfort for markets in tough times and investors will want to see proof that this will continue in future. It could be a rude awakening. The Fed’s most pressing priority is securing better monetary traction to deal with future crises and it means getting interest rates to higher levels as soon as possible. It could mean three more rate hikes this year – at least.

In Europe, the succession battle waging in the European Central Bank could see serious downside for markets accustomed to dreams of never-ending stimulus. ECB President Mario Draghi has done a good job managing acute recession, deflation and debt default risks in the last decade but the winds of change are blowing hard. Draghi holds office until 2019 but who comes next is critical.

As the battle lines are drawn it will be epic for interest rate perceptions. European markets are on a countdown to more costly money as the power struggle intensifies between the ECB’s hawks and doves. Clearly Germany’s hard core monetary conservatives want to be back in the driver’s seat and that means wrestling the ECB presidency back into German hands again.

Germany believes the last decade was a lost opportunity for monetary stability and is determined to set things straight again. In the Bundesbank’s view, super-stimulus has put European inflation at risk and left the ECB’s monetary credibility in tatters. Change is coming and the markets must embrace the inevitable transition to tighter rate policy.

The days of easy money are over and markets are heading into a new era of double trouble for rate perceptions in the US and Europe. Where the US leads, Europe will dutifully follow.

David Brown is chief executive of New View Economics