Watching market reaction over the past two days, you could be forgiven for thinking interest rates are being cut, the rare “soft landing” bird is resting on US Federal Reserve Chairman Jerome Powell’s shoulder, eating crackers, and there really is a Santa Claus delivering a record high for the Australian stock market and all who sail in her.
Well, that’s all sort-of true, maybe. But before rushing out to spend the gains tumbling into your superannuation fund on a bigger Christmas tree, remember that this burst of market enthusiasm is based on central bankers’ ability to forecast the future, something universally acknowledged as very tricky indeed.
What lit a fire under already warm markets on Wednesday night was the Federal Reserve Open Market Committee members looking into their crystal balls, chook entrails and tarot cards and, on average, forecasting that they will vote to cut rates three times next year, reducing their benchmark rate from 5.35 per cent to 4.6 per cent by Christmas 2024.
That of course depends on another Fed forecast turning out to be correct, that America’s inflationary episode is over, with the CPI locked into steadily falling to the Fed target rate of 2 per cent.
I repeat, these are central bankers’ forecasts. They do not come with a guarantee. Ask Philip Lowe about that.
The closest Fed Chairman Powell came to being definitive was saying his committee members “think it is not likely that it will be necessary to raise rates further”.
So Powell effectively called this cycle of rate rises over. As Powell nearly said at a media conference, if the rises are over, the next question must be when do the cuts start.
With the benefit of hindsight – always better for forecasting – the cycle actually stopped in July when the Fed last increased rates. It just took five months to confirm it.
That helps make our Reserve Bank’s November interest rate rise look all the more like a shag on a rock, with subsequent weak growth figures reinforcing the likelihood that it was a mistake. (Told you so.)
Our central bankers continue to warn that inflation here remains too high, hence their restrictive monetary policy. They might do well to consider Chairman Powell’s justification for considering rate cuts while American inflation was still above its 2 per cent target:
“The reason you wouldn’t want to get to 2 per cent to cut rates is that … it would be too late. You would want to be reducing restrictions on the economy well before 2 per cent, or before 2 per cent, so you don’t overshoot … it takes a while for policy to get into the economy.”
Powell has effectively declared an end to rate rises in the US. Photo: Getty
The Financial Times‘ Unhedged columnist reinforced the point:
“It is hard not to interpret the statement, the summary of economic projections, and the press conference as together reflecting a desire not to repeat the mistake the Fed made at the beginning of this cycle – waiting too long to increase rates – by waiting too long to cut them.
“The Fed has pivoted and is now clearly as focused on employment as it is on inflation.”
The RBA’s language – and last month’s rate rise – is keeping inflation as its primary target with employment a lesser problem and Jim Chalmers’ problem at that.
The RBA and every economist in the pet shop acknowledge that monetary policy works with a lag. As Powell warned, if you wait until inflation is in your target zone, it’s too late to cut.
Meanwhile, back with the opening paragraph of this column, interest rates are coming down via the money market before the RBA or Fed officially cut.
Australian Government 10-year bonds started November with a yield of 4.96 per cent. They finished this week at 4.14 per cent.
Bond yields were falling before the Fed meeting as the markets were doing their own forecasting, not waiting for the official word.
“Soft landings” are indeed very rare birds – episodes of a central bank raising rates enough to calm inflation without tipping the economy into recession.
Powell is not claiming to have achieved one and remained very cautious in his wording:
“I think you can say that there’s little basis for thinking that the economy is [in] a recession now. I would say that. I think there’s always a probability that there will be a recession in the next year, and it’s a meaningful probability no matter what the economy is doing.”
On top of his other careful wording, that brought to mind Alan Greenspan’s most memorable quote, most commonly expressed as: “If you think you understand what I am saying, you do not understand what I am saying.”
(There are a couple of versions of it: “I know you think you understand what you thought I said but I’m not sure you realise that what you heard is not what I meant” and “If I seem unduly clear to you, you must have misunderstood what I said” with the latter the one most likely to be correct.)
But the pivot is clear. If the Fed members prove to be good at the chook entrails business, the forecast 4.6 per cent rate would still be higher than the RBA’s present cash rate of 4.35.
As for there really being a Santa Claus, Virginia, yes, there is indeed a seasonal Santa Claus rally more often than not for the ASX.
It was turbo-charged on Wednesday night with the extra juice provided by expectations of falling interest rates. The ASX 200 is now within a couple of percentage points of equalling its all-time high of 7632, touched briefly in August 2021.
This is more than a little remarkable when you consider:
Yet housing prices are at record highs and our stock market is approaching one.
Not only is there a lot of faith being placed in those Fed forecasts, the expectations of what they will deliver seem “very brave, Minister”.
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