In Paris today at the the Amundi World Investment Forum. Just sat through the first day of this very popular event and two really interesting sessions with some big ideas knocking around.
First a rare insight in central bankers via an interview with Janet Yellen, ex chair of the US Fed. What was striking was how much she admitted that until recently, many of the traditional “rules” of central banking such as the Phillips Curve didn’t seem to work. Take one example. She seemed genuinely flummoxed that growth had picked up, unemployment was low but price pressures – and wages – didn’t seem to be working in the way they used to. This flouring of the rules perhaps helps explain why the Fed has kept rates so low for so long.
But then Yellen observed, crucially, that economic “behaviour may become much more rule like” which implies that the Fed might revert to ‘form’ and more aggressively increase rates. Which is precisely what frightens most institutional investors in the audience i.e the Fed over reacts.
But then, just in case this signals the wrong message to a well connected audience, she also observed that she “wouldn’t count on productivity picking up speed”, which is code for saying that growth and thus inflation might not over shoot. Thus rates might not go up much more. So don’t panic! Or maybe we should py more attention to those bank rules??? Which narrative do you believe?
Which brings me nicely to Kenneth Rogoff (and Nouriel Roubini) in their macro economic roundtable a little later in the afternoon. As ever Rogoff was on spiky form and made what I think is they key insight of the day.
Most observers have tended to justify the New Normal or low interest rates based on central bank actions. But what happens if central banks are simply reacting to underlying global real rates which have trended lower i.e central bank policy follows deeper underlying factors related to productivity levels. In this narrative productivity and thus growth rates have trended lower dragging down interest rates and forcing the hand of the US Fed. Thus the author of the New Normal is revealed not as central bankers but under investing capitalists and excess savings and capital.
There’s a twist though. Rogoff argues that productivity growth may have recently slowed down but it might be about to pick up speed again because of technology and disruption. An ‘incredible explosion’ might be on its way which could drag up productivity growth.
This in turn could require a huge investment boom which could push up the natural real interest rate. If that happens then interest rates could suddenly move higher and the New Normal of low rates could crash and burn.
But Rogoff also suggested a more short term (nightmare) scenario, one which has also been keeping me awake.
Trump takes on the Financial Swamp.
Like Rogoff I sense that the Fed has been a bit “too aggressive” and that the Fed has been asserting its independence. But what happens if the Fed over reacts and pushes up rates too aggressively – to prove its hawkish, independent credentials. This could cause a scare which could slow down Making America Great Again.
Imagine the Fox headlines. Financial elite kill US jobs just as Trump delivers.
One thing we do know is that in a fight between saving his reputation and attacking established institutions, Trump will always choose the former. His whole reason for existence is to unsettle the established order and the US Fed could become his target. He could aggressively seek to emulate his role model Erdogan in Turkey and nobble the ‘unaccountable’ central bankers. My guess is that the Fed would probably end up giving ground which in turn would be met with real relief by Wall Street and bullish equity investors. But if this happens the message is that central bankers are not so independent afterall. Arguably central bank monetary policy has increasingly acted as a substitute for fiscal policy and thus cannot remain detached from politics. You don’t have to be a leftist to think that the mantra of central bank neutrality might not work in a populist era. But if this mantra does crumble, expect fiscal incontinence and surging inflation – followed by eventual crisis. And war, the handy get out of jail card for any populist looking to shore up their shredded credibility
One last observation from the Amundi event. In Yellen’s conversation I thought it was fascinating that she name checked two potential sources of risk within the investment world – leveraged hedge funds and ETFs vulnerable to a mismatch between their liquid daily trading and less than liquid underlying assets. I’m not entirely sure either are actually that great a risk but its illuminating nevertheless.
ETF issuers need to be careful – the central bankers ARE watching and worried.