It’s being hailed as a policy U-turn. After months of interest rate hikes, and the wordsmithing that goes along with them, suddenly the pause button has been pushed – first by the Bank of Canada and now by the Fed. The ECB warned it would be late to the party, and now may not show up at all. And the Bank of England – well, it has other things to worry about. The words and actions of central banks have been one of very few signals in the post-recession turbulence that normalization was even possible. Does the rapid shift in position spell trouble?
First, let’s review the data. The Fed’s tightening spree is now into its 37th month. Its target level saw a tentative lift-off from .25 per cent late in 2015. It took a year to see the next hike, and since then, a measured sequence of quarter-point moves to the current 2.5 per cent. At least two more increases were thought inevitable this year, until last week’s bombshell. The Bank of Canada – normally in lock-step with the Fed – lagged this time by about 18 months. Its subsequent moves weren’t as tentative as the Fed’s first steps, but the overall pace of increase has been slower. Europe has been quieter: the Bank of England has hiked only twice since late 2017, and the ECB announced plans to begin raising policy rates in mid-year.
Tightening is very gradual
Second, some historical perspective. Of the prior five Fed tightening phases, this one is clearly the most gradual, and by far the most delayed. In the past, rates have rarely remained at trough levels for more than a year; this time, it was seven. The Bank of Canada’s story is roughly the same. The Bank of England has had gradual tightenings before, but nothing like this one. It seems that current caution is happening in an already unusually cautionary moment – hardly comforting.
Third, how about a dash of context? In case we are tempted to think that this should be just like tightenings of the past, let’s recall that in one key respect, this time around is historically unprecedented. At the same time as the cost of funds is rising, vast amounts of liquidity, made available through quantitative easing, are being sopped up. True, the Fed is the only central bank actively doing this at the moment, but the effects are worldwide. The ECB has turned off the tap, but they have yet to pull the plug. Even so, expectations are influencing financial markets in ways that will take years to fully understand – this is virgin territory for policymakers, pundits and professional money movers, and ‘tentative’ seems a wise battle plan.
How are central banks doing?
A fourth point is on progress. Thus far, the plan can be judged a success. Until recently, growth was accelerating, and against predictions to the contrary, inflation has remained very well-behaved. As unprecedented as monetary conditions are, the slow steps of the Fed have thus far been a success.
Which brings us to recent statements. Taken in isolation, the Fed’s unqualified comments about “global economic and financial developments” might seem almost inert. But the reference immediately following, pledging “patience” in regard to “…future adjustments” begged – and received – a torrent of attempted interpretation. The Bank of Canada was more clear, referring specifically to the effects of the “US-led trade war”. It is clear in the general discourse that US growth is not the issue; it is marching on, seemingly unhindered by policy and financial market turbulence.
Why the pause?
This begs a clear question: is the present pause actually policy-induced? Is slower growth something that humans have unwittingly brought on themselves? We may never know, but what is hard to dispute in the data is clear evidence of pent-up demand in both the US and Europe. Investment has never really recovered in this cycle. It has been waiting for a flash-point – a moment of realization, where we collectively understand that the meagre post-recession growth is now a thing of the past, and that our job is now to create capacity to meet the demand that renewed growth is bringing to the world stage.
The bottom line?
Trade policy confusion is producing an investment hesitation that has occurred at the very moment in the cycle that we’d be seeing an investment ignition. Let’s hope the matches don’t get too wet – that we can solve our trade policy problems in time to rescue the thing that policy is purportedly aiming at: growth.
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