In the terrific 1992 film Glengarry Glen Ross, Al Pacino’s Ricky Roma character says, “What you’re hired for, is to help us … does that seem clear to you?” The central banks may not have understood the memo’s directive. These institutions, from the Federal Reserve to the Bank of Japan (BOJ), are keeping the global economy intact and helping hedge funds by using the old-fashioned tools of glue and gum. The world recently witnessed how much monetary policy can inflict damage on the financial markets, proving that they are certainly not the smartest men and women on the planet. Instead, they are flying by the seat of their pants and putting their index finger in the wind to determine their next chess, er, checkers move.
A Week for the Central Banks
By now, armchair experts have heard about the Japanese yen carry trade. Investors will borrow in a low-interest-rate currency, such as the yen, to reinvest the proceeds in high-yielding assets. With the BOJ raising interest rates a couple of times by just a few basis points, traders panicked and sold their carry trades to cover losses elsewhere. This, of course, resulted in bedlam on Wall Street. Tokyo officials have ostensibly learned their lesson and informed the hedge funds that they will not make this policy blunder again.
Shinichi Uchida, the BOJ deputy governor, confirmed on Aug. 7 that the central bank will not hike interest rates when financial markets are unstable. “As we’re seeing sharp volatility in domestic and overseas financial markets, it’s necessary to maintain current levels of monetary easing for the time being,” Uchida said in a speech to business leaders in the northern Japanese city of Hakodate. “We won’t raise interest rates when financial markets are unstable.”
Asian markets were pleased by the news – especially by the “easing” part of his remarks – as the leading benchmark indexes, including Japan’s Nikkei 225, rallied as much as 2%. The Japanese do not want to be blamed for a market crash and will refuse to be the fall guys! The move will now allow the smart money to manage risk, adapt to conditions, and unwind trades ahead of any BOJ moves. Put simply, the monetary authorities are giving a wink, nod, and nudge to the Wall Street titans to employ any necessary strategies to shield their wealth or take advantage of any opportunities ahead of the next rate hike.
But the question is: If a rate hike is not in the tea leaves now, then when will the tightening commence? If the world’s fourth-largest economy shows weakness, maybe a rate cut is in the forecast. Perhaps this is where the Federal Reserve and other advanced central banks enter.
In Case of Rain, Carry an Umbrella
During the great Wall Street Panic of August 2024, market watchers called for the Fed to employ an emergency 50-basis-point rate cut, followed by deeper reductions to the benchmark federal funds rate at the September, November, and December policy meetings. The futures market is presently pricing in a half-point cut at next month’s powwow, according to the CME FedWatch Tool.
But if the Fed lowers interest rates, it will not be due to desperate retail bulls demanding their next fix of monetary easing. Instead, Chicago Fed President Austan Goolsbee says the decision will be based on what the data are conveying to public policymakers. If the statistics suggest a weakening economic landscape, then it is time to react.
“The Fed’s job is very straightforward: maximize employment, stabilize prices, and maintain financial stability. That’s what we’re going to do,” the former White House economist told CNBC in an Aug. 5 interview. “We’re forward-looking about it. So, if the conditions collectively start coming in like that on the through line, there’s deterioration on any of those parts, we’re going to fix it.”
But while Goolsbee does not believe the United States is slipping into a recession following the weaker-than-expected July jobs report, he does not think the central bank should continue being restrictive. “Should we reduce restrictiveness? I’m not going to bind our hands of what should happen going forward because we’re still going to get more information. But if we are not overheating, we should not be tightening or restrictive in real terms,” he added.
The Eccles Building is at a crossroads. First, it is likely that the Fed will reduce the policy rate in September, whether it will be a quarter-point or half-point cut remains to be seen. Second, if inflationary pressures return – used car prices unexpectedly surged in July and the input prices in the Institute for Supply Management’s (ISM) Services Purchasing Managers Index (PMI) suddenly climbed in July and remained elevated – the Fed would have to tergiversate and repeat the mistakes of the 1970s and 1980s. The central bank has another jobs report and several sets of inflation data before the next meeting, so they will prove quite critical.
What is comical is that the Fed and economists endorse the Friedmanite adage of monetary policy functions with a “long and variable lag,” meaning that if the Fed employed a 25-basis-point or 50-basis-point cut as soon as tomorrow, it would not be felt for some time. C’mon, man!
Blink and You’ll Miss It
Who will capitulate first? The BOJ or the Fed? Tokyo officials have admitted defeat and are a slave to the markets. The Fed is a bit coyer in its language and possesses plenty of ammunition and cover to employ stimulus measurements by stealth. The consensus is that Fed policy is restrictive, but if it were, then financial conditions would not be almost as loose as they were before quantitative tightening began in March 2022. So now the financial markets will demand a half-point reduction to the benchmark rate in September. If it does not deliver, there might be bedlam (again) on The Street.
Ultimately, there is a cavalcade of challenges for the foreseeable future: recessions, interest rates, carry trades, and the 2024 election. Grab the popcorn, read the memes, order a case of Pepto Bismol, and wait. The final stretch of the calendar year will be compelling times, indeed. Perhaps everyone should just T-bill and chill while the central banks depend on glue sticks and bubble gum to prevent the ship from sinking.
