This week, financiers’ eyes were fixed on the Federal Reserve. No wonder. On Wednesday, the US central bank increase the exchange rate at the most positive rate for 22 years, as Jay Powell, the Fed chair, has finally admitted the obvious: inflation is “Too high”.
But when investors analyze Powell’s words, they should put their mind to a central bank on the other side of the world: the Reserve Bank of New Zealand.
In recent years, this stroller has often not been an indication of larger global trends. For example, in the late 20th century, the RBNZ pioneered inflation targeting. More recently, it accepted climate reports before most other companies.
Last year, it started Tightening policy before most partners. And this week, it went further: latest financial stability report warns of the “legitimate” possibility of a “chaos” drop in house prices, as the era of free money comes to an end.
Not surprisingly, the RBNZ also said it hoped to avoid a destabilizing crash. But here’s the bottom line: Kiwi central bankers know they’re having an asset bubble, as property prices have jumped 45% over the past two years and are “still estimated to be above sustainable levels.” “. This reflects both the extremely low rates and the shockingly bad housing policy in the country.
And now it’s telling the public and politicians that this bubble needs to deflate, hopefully well. No more “putting” the Kiwi – or a central bank safety net to avoid falling prices.
If only the Fed were just as honest and direct. On Wednesday, Powell tried to engage in some simplistic rhetoric, by telling the American people that inflation was creating “significant difficulty” and that rates would need to rise “rapidly” to break this. He also stated “Immense admiration” to his predecessor Paul Volcker, who raised interest rates to tackle inflation five decades ago, even at the cost of a recession.
What Powell did not do, however, was discuss asset prices – let alone admit that they have been so inflated by cheap money lately that they are likely to fall as policy changes.
A central-banking purist might argue that this omission simply reflects the nature of Powell’s mandate, which is “to promote maximum employment and stable prices for the American people.” ”, as he said on Wednesday. In any case, the evidence for the short-term risk of falling asset prices is mixed.
Yes, the S&P 500 has dip into edit territory twice this year, with a significant drop in tech stocks. However, the US stock indexes really up 3% on Wednesday, after Powell offered a more dovish tone than expected by ruling out a 75 basis point increase at the next meeting.
And there’s no sign of US property prices falling right now. Opposite, Case-Shiller index House prices are 34% higher than they were two years ago, according to the most recent data (February).
However, the beggars believe that Powell can crush consumer price inflation while keeping asset prices steady. After all, a key factor that has lifted this price to a high is the Federal Reserve’s $9 billion balance sheet that nearly doubled during the COVID-19 pandemic (and has since expanded). nine times since 2008).
And, arguably, the most important aspect of the Fed’s decision on Wednesday was not its $50 billion rate hike, but its commitment to begin cutting its holdings of mortgages and treasuries. to $47.5 billion per month starting in June – and speeding this down by $90 billion monthly from September.
Based on Bank of America calculation, which means the balance sheet will shrink by $3 billion (in other words, a quantitative tightening) over the next three years. And it’s very unlikely that the impact of this is priced in.
After all, QT on this scale has never happened before, meaning neither Fed officials nor market analysts really knew what was going to happen. Or as Matt King, an analyst at Citibank, puts it: “The reality is the tightening hasn’t really started yet.”
Of course, some economists might argue that there’s no reason for the Fed to assess this risk to asset prices right now, given how this could affect confidence. That won’t make Powell popular with a White House facing a difficult election, nor will it help him achieve his stated goal of a “soft” economic landing (or ” gentle”), based on consumer sentiment was shaken in recent months.
But the reason why it should be obvious is that decades of extremely lax policy have led many investors (and households) to become addicted to free money, and act as if this were permanent. Furthermore, since the Fed has repeatedly rescued investors from rapid asset price corrections in recent years – most recently in 2020 – many investors have the innate assumption that the Fed has “put”.
So if Powell really wants to emulate his hero Volcker and take tough measures for long-term economic health, he should take a leaf from the Kiwi book and tell the public and the politicians American experts that many assets have suffered from unsustainably inflated prices by freeing money.
That may not win his fans in Congress. But no one ever thought it would be easy to deflate a multi-million dollar asset price bubble. And the Fed has a better chance of doing this smoothly if it starts gently and early. Wednesday’s protest shows the consequences of staying silent.
