Markets doubt Fed's ability to defend economy, spur inflation


Here's christine lagarde chairwoman of the international monetary fund and a newly nominated e._c._b. President earlier this year. The bottom line is that after two years of solid expansion the world economy is growing more slowly then unexpected and risks are rising. Growth concerns have been at the heart of the dovish pivot. We've seen from central banks. This year and markets on our economists alike now expect the fed just start delivering rate cuts as soon as this month. Here's fed chair jerome powell testifying on capitol hill just last week and our june meeting. We indicated did that. In light of increased uncertainties about the economic outlook in muted inflation pressures we would closely monitor the implications of incoming information for the economic outlook and would act as appropriate to sustain the expansion the market reaction to all of this has been noteworthy typically growth concerns rise investor demands shifts towards less less risky assets that means investors usually buy bonds causing yields to decline and sell stocks causing equity prices to fall a recently. We've generally seen the reverse with bond yields declining while stock prices have risen to all-time highs many think this is because fed cuts just protecting against a downturn rather than actually responding to one but others things stocks and bonds are sending very different messages about growth with bond investors more worried about recession while equity investors are focusing on the upside of course markets are fickle these days and this pattern between stocks and bonds has waxed and waned but the broader questions remain how concerned about growth growth should we really be and are fed actions which some believe have been too responsive to markets in the end helping or hurting the growth outlook from here the the answer to these questions and implications for asset performance are top of mind. I i turned to legendary investor dollar-euro founder and co chief investment investment officer of bridgewater associates to see what he makes of these developments. Dalia thinks the recent market action makes sense but is worried about an adverse environment for growth in nathen ahead. We're really grappling with the question of whether there is a disconnect between stocks and bonds and what their pricing in terms of growth stock values and fundamental we determine why the present value of expected cash flows and when interest rates go down that's a positive dachshund present value since so when i look at the decline and interest rates and the move to do a more stimulus effect policy i look at that as a temporary positive of effect on stocks by that it is a non sustainable effect on stocks for the long run because there is a limitation as to how far interest rates i can go down and how quantitative easing can work so when interest rates go down causes the present value of assets to rise but <hes> it also means that there's less stimulation in the bottle because you get closer to interest interest rates approaching zero think of this as a stimulus that is in a bottle and it's running out so if you use it yes you can you can get a kick out of the economy and a kick out of the markets but the important shift in the world will be coming when monetary policy is not very effective when they're essentially out of the stimulant is in the bottle dalia was concerned that the fed and other other central banks are running out of stimulus. He also thinks the fed's shift to a more dovish. Monetary policy was appropriate and if anything could have come sooner and he doesn't give much credence to the view that the fed has been responsive to bond market concerns. Here's what he had to say on the fed it worry too much about a strong economy with breath limited capacity to expand and they were worried about the combination of the fiscal stimulation and the low rates of employment and and that inflation would accelerate they were very worried about the classic cycle happening in my opinion too worried about that and so going into two year end they over tighten the ending <hes> then did a sharp reversal opinion and appropriate sharp reversal because the inflation risks and the growth risks are exaggerated but ultimately there is a narrative in the markets now has been overly responsive to bond market pricing so just to clarify you don't agree with that. View doesn't carry much weight with me. I think that people who say that presume that the fed things the bond market is right and one can conjecture at the bond market see something that the fed needs to follow or or one could say that the yield curve becoming inverted and what is discounted and the price means something that the fed should be more cautious. Those was a reasonable statement. Realistically you have to ask what is that something that is causing the long rates to go down while the economy's slowing slowing for a number of reasons and then of course we're fairly late in the cycle we have the greater wealth gap and optimism polarity laverty and geopolitical issues particularly with china so if you were to look at the world economy as a whole you would say say that there should be an easier monetary policy and if you look at the interest rate differentials and the currency movement and what the federal reserve i can do it's reasonable that interest rates would go down and that they would be led by the market at a faster pace <hes> than <hes> the fed goldman sachs strategist agree that recent market actions make sense amid rising growth uncertainty. They actually argue that despite very high index levels you can nc growth concerns reflected across risky assets in the performance of higher quality and defensive sectors in equity credit and commodity markets so bond markets are less of an outlier than they first appear beyond hot seats. The firm's chief economist says these growth concerns are overdone if anything he's more concerned about the direction the fed and is less convinced that the benefits of easing here outweigh the potential costs namely the increased likelihood of so-called hard landing for the u._s. economy. How worried should we really be about u._s. And global growth it seems to me that the growth outlook while clearly not a strong as in two thousand seventeen two thousand eighteen eighteen is still pretty decent. We're looking for growth in the two percent range in the second half of this year and then actually a little bit more than that in two thousand thousand and twenty which would still put us a touch above or estimate the underlying trend pace of growth which is in the 175 range so <hes> yeah we're we're we would say cautiously optimistic that were still going to see decent one reason for this is the easing and and financial conditions which has taken place really for most of this year and again more clearly in recent weeks which should mean that the impulse from financial financial conditions to growth is going to become somewhat more positive as the year goes on that trip b visible and things like homebuilding where there's a very direct impact from for mortgage rates and also personal consumption where equity prices obviously matter so how much should the recent shift toward and even more dovish bias from the fed which has this recently prompted us to assume that we are going to see some cuts this year how much should that temper concerns about growth and inflation disappointments. I mean does that really need on all well. I think it helps easier monetary policy. I think does have real effects. I think in the u._s. It's uh relatively easy to generate positive impulses because the funds rate is two point four percent strictly in positive territory you can law or the funds rate you can thereby generate easing financial conditions that will have an impact on growth and of course some of this is already frontloaded market pricing anticipating fed cuts cuts in the us to me doesn't look particularly necessary. I mean to me it. Actually looks like the economy is fine even without monetary easing so here. It's really not a question of whether monetary easing is effective but whether it's necessary. Do you think the fed is setting up a policy mistake by intending or signaling. They're on the verge of cuts. It's a question of costs and benefits so i think when the economy is generally fine and you're maybe providing a little a bit more additional stimulus. The benefit is relatively limited and it's possible that ultimately over stimulate the economy you push the unemployment unemployment rate down to a level that is too low to be sustained in the longer term with inflation at about two percent and then and you need to increase the unemployment rate over time and historically. It's been very difficult to do that without a recession. There's never been an increase in the average of the unemployment rate of more than thirty five basis disappoints that wasn't associated with the recession and i think that's probably a somewhat bigger issue now than it might have been comparable episodes in the past because because of some of the politics and some of the influence on the fed from the electoral calendar for example we are going into an election year if they we do deliver some insurance cots and two thousand and <hes> nineteen <hes> as we're we're we're projecting it will be much harder to to unwind. Those insurance cuts in two thousand twenty. If it turns out that the not needed or maybe even counterproductive <hes> now if it was a very clear cut that case i think they would hike in two thousand twenty but at the margin it's just going to be a harder as you approach a probably very contentious presidential look so do you think the market is too concerned about growth and maybe not concerned enough that the fed could be heading ultimately atlanta counterproductive jim action. Yes <hes> i. I am concerned about that. I think that the market is somewhat concern. On growth. I think markets to lawn flation asian markets underestimating the extent to which the current weak inflation numbers are driven by more special factors. I think what chairman paul's at at the me press conference not doing press conference but the main press conference about the outliers in the core p._c. A._c. numbers and the much stronger message sent by the dallas fed's trim mean p._c. Index all of those things i thought were correct then and they remain correct saw aw i think we'll see you see a rebound inflation and not as concerned about inflation expectations as many in the markets partly because i think that break even inflation compensation in the bond. The market is not a great measure of inflation expectations. The service actually still look consistent with inflation expectations that are anchored around two percent so yeah i mean i i have a different sense of the relative risks and therefore also a different sense of where you're more likely to make a mistake i think the dominant market view is that the fed's been too slow and they continue to be too slow and they need to move expeditiously in the direction of easier policy. My view is that if they moved too quickly and to aggressively than they are at risk of over stimulating the economy and thereby raising the risk of a hard landing you know maybe not in twenty twenty but <hes> at some point in the future janas also somewhat concerned about the amount of political pressure on the fed which poses a threat to its independence so obviously the other factor here has been the white house's pressure on the fed to keep rates low or cut further. How much do you think that's benefactor. Do you think there there is reason to be concerned about the independence of the fed well. I think there is some reason to be to be concerned. I mean the pressure has been very overt. Coach and the desire to appoint political loyalists to <hes> fed positions has definitely been there so there has been talk about firing or demoting chair paul. It's a little unclear how far that <hes> that wind but you know all of goals things are of course threats to the independence of the of the federal reserve. I think the fed is still independence. Still does act independently leave. I don't think that chair paul and his colleagues take orders from the white house. However i also think that there is sort of an indirect avenue the new for pressure on the fed that goals via the bond market because clearly the bond market is responsive to political chatter and reports of much more dovish appointees appointees for the board of governors or demands for for rate cuts and to the extent that the f._o._m._c. puts more weight on bond market pricing and setting a <hes> its own policy. I think that is way in which the political pressure can actually have some impact so for me. This is another reason to be somewhat skeptical that that we should be putting all that much weight on bond market pricing and be a bit more resistant to the idea of the fed should be just deliver what the bond market's pricing so what would this slightly more optimistic outlook mean for the sustainability of the broader rallies. We've seen in pretty much everything this year even if growth holds up as our economists m._s. expect goldman sachs research things were still likely to see to federate cuts and a broader bond rally prevail but that won't do much to boost stocks going forward according to our achieve u._s. Equities strategist david causton who sees growth and policy uncertainty keeping equities moving sideways through your end as positioning

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