PAUL KRAKE: Markets obsess over trade while Central Banks won’t
Markets obsess over trade while CB won’t
There are two big mistakes that investors make when looking at the future path of monetary policy by central banks everywhere. First is that investors make tactical decisions based on what they believe a central bank should do, not what they are going to do. This is a very important distinction. When you listen to pundits talking about “the Fed should do this, or the Fed should do that”, this is merely a projection of opinions and biases versus the cold hard facts of data and more importantly, mandates. Despite what many may think, Central Banks are not in the business of pre-empting an acceleration or deceleration in activity or inflation. The Fed didn’t mention the economic impact of tax cuts until they were passed by Congress, even though we knew they were well telegraphed. The Fed waits for data to turn and then they respond.
The second mistake is more contentious as it is conventional wisdom amongst many of you, and that is that the Federal Reserve alters policy based on the performance of US equities. I personally don’t believe this to be true. While central bank policy since the global financial crisis has been incredibly loose and supportive of asset markets, I do not believe that period of market weakness has ever really prompted a change in the course of action. Fed governors may talk a little dovish when credit widens, or stocks fall, but in the greater scheme of things US stocks have gone up pretty much in a straight line since March 2009 with three exceptions. 1) the European debt crisis 2) The RMB weakness of August 2015 / January 2016 and 3) the range bound nature of the past six months.
Did the Fed really alter course during that period? Well, not really. The Fed was already undertaking QE when the European debt crisis unfolded. One can argue that the Fed not tightening in September 2015 was a change in stance, or was it a precursor to the Q1 2016 Shanghai Accord, the commitment to ease both the RMB and USD simultaneously? And today, the Fed continues to go along in its tightening cycle despite an array of market fears. The facts are that the Fed responds to US data and nothing more.
Combining these two, I must conclude that the Fed isn’t going to alter the path of policy specifically regarding trade tariffs, until data starts to slow. Even if markets continue to be obsessed by it. Weak EM equities isn’t going to alter the Fed’s path. Snarky tweets and the academic articles calling the end of Western alliances, aren’t going to see the Fed change course. While it will be sentiment that will determine the multiple that investors are willing to pay for both equity and credit assets, eventually, negative sentiment has to eventuate into hard data for this overwhelming bearishness to be proven correct. My argument that asset prices, especially in EM are far too negative regarding the outlook for growth and profits is that it is not being seen in the data. Maybe we all may need to be a little more like central banks. Instead of inventing growth and profit deteriorations based on scenarios with uncertain outcomes, maybe we should stick to what we know: Global growth, especially in the US, is in great shape. We do not have an EM growth crisis. The Fed has given us a clearly defined policy course. China is relaxing policy and not deleveraging. Europe is bottoming. Global profits are in great shape. Until this changes, what is there to be bearish about? USD continues to soften. EM stocks will rebound.
The Bank of Canada meets on Wednesday and is expected to raise rates by 25bps. The central banks of Malaysia and South Korea should stand pat. On Monday Japanese Current Account Balance. Tuesday, China PPI and CPI, and UK IP. Wednesday, Japanese Machine Orders and PPI. Thursday, Germany and US CPI, and Indian IP. Friday, Singaporean and Japanese IP. US Bank earnings start.