TOKYO – About the only thing US Democrats and Republicans agree on is that the Federal Reserve is behind the inflation curve.
On the left, former Treasury Secretary Lawrence Summers and ex-White House economist Jason Furman worry that Fed Chairman Jerome Powell continues to miss the plot. On the right, former Council of Economic Advisers head Glenn Hubbard and monetary guru John Taylor seethe over the Fed slow-walking a tightening cycle that should have begun months ago.
Yet the real confusion is here in Asia, where central banks are doing their jobs in ways Powell won’t. From Seoul to Singapore to Wellington, officials are actively hitting the brakes as inflation risks intensify. They are getting ahead of the inflation curve.
Even Bank of Japan Governor Haruhiko Kuroda is taking clear steps toward tapering a US$5 trillion-plus balance sheet. The Fed, meantime, continues to talk about a rate hike. This uncertainty is making for some choppy trading in Asian asset markets.
In recent comments, “Powell effectively admitted the Fed has been behind the curve and now must get its act together to get inflation to more acceptable levels,” says Fawad Razaqzada, an analyst at ThinkMarkets. “If that means upsetting financial markets, then so be it.”
Fair enough. But why, Razaqzada and peers ask, is Powell holding off on making up for lost time until March, the next time Fed policymakers meet? If even Powell seems to be suggesting the Fed should have tightened in the second half of 2021, Asia is at a loss to figure out the logic of US policy.
Long-time Fed watchers like Wall Street strategist Ed Yardeni are perplexed, too, by the mixed signals coming from Powell from day to day. As Yardeni put it: “The labor market is strong. Inflation is a problem. Can we just get on with what needs to be done, please?”
Fear of the fallout
The problem, of course, is that Powell fears the fallout from a rate hike. And he’s hardly alone.
Nobel Prize laureate Joseph Stiglitz, who was Democratic president Bill Clinton’s top economist, worries a tightening now would do far-reaching damage. Nor would it fix the supply-chain disruptions partly behind rising inflation, Stiglitz argues.
Powell, though, may be risking something else: the loss of trust in the Fed necessary to support the dollar, manage interest rates and maintain calm in stock markets.
That has hedge fund managers like Bill Ackman at Pershing Square Capital Management arguing that a half-point hike by the Fed could be needed just to “restore its credibility.” He favors a “surprise move to shock and awe the market, which would demonstrate its resolve on inflation.”
But the odds still favor the Fed moving slowly and modestly, 25 basis points at a time. “We think it is unlikely the central bank will open the possibility of a [half-point] hike in March,” says economist Luigi Speranza at BNP Paribas. “We would regard more frequent hikes as the most likely risk.”
JPMorgan Chase CEO Jamie Dimon thinks the truth lies somewhere in between. He says there is “a pretty good chance there will be more than four” rate hikes this year. “This whole notion that somehow it’s going to be sweet and gentle and no one is ever going to be surprised, I think it’s a mistake.”
Asia is not so sure, though. There’s a certain disconnect in how Powell appears to view economic risks, says Hong Kong-based analyst Will Denyer.
“Why the haste if policymakers expect inflation to moderate?” says Denyer of Gavekal Research. “First, they see inflation risks skewed to the upside, as it is not apparent how quickly supply disruptions will clear and wage pressure will ease. Second, the starting point is extremely accommodative monetary policy and high inflation and inflation expectations.”
The trouble for Asia is that all this leaves markets in suspended animation. It might have been less disruptive for the Fed to have tightened in, say, December than the constant drip, drip, drip of news and intrigue between now and March’s policy meeting.
‘Do I feel lucky?’
As Ian Harnett at Absolute Strategy Research told Bloomberg: “You’ve got to ask yourself just one question: ‘Do I feel lucky?’ This isn’t just the question that Clint Eastwood famously asks in the film Dirty Harry, it’s also the question facing investors as they look to forecast the number, and timing, of Fed rate moves in 2022, in the light of the uncertainty generated by the recent dramatic Fed pivot.
“Add in uncertainty about when inflation will peak, Omicron, together with whether Russia might invade Ukraine, and successfully forecasting markets looks increasingly like buying a lottery ticket.”
It’s not clear if there will be any winners in Asia. Least of all China, whose leaders have more than enough worries for 2022. From weak global demand to Covid-19 risks as the Winter Olympics begin to rising inflation to domestic challenges facing highly-indebted property developers.
The People’s Bank of China (PBOC) has been easing to safeguard gross domestic product (GDP) and calm credit markets roiled by defaults. Yet a sliding yuan is not necessarily in Beijing’s best interest as the dollar rallies.
“If Powell confirms that rate hikes will begin in March and suggests that they need to aggressively control inflation with more than four rounds of tightening, the US dollar should soar against all of the major currencies,” says analyst Kathy Lien of 60 Second Investor.
A weaker yuan both increases the risks of importing inflation and makes it harder for indebted property developers to make payments on their dollar-denominated debt. It also reduces the purchasing power of China’s fast-growing middle class.
The rest of Asia can’t help but recall the shocks from past Fed tightening campaigns – from 1994 to 2015. This time, that includes risks associated with the end of quantitative easing and formal rate boosts that send US yields skyward.
Clear and present danger?
“Powell’s indication that rate hikes and QT might be faster than the market expects certainly raised concerns in Asian equities,” says strategist John Vail at Nikko Asset Management. “Globally, stocks with very high valuations will need to prove that their outlooks are even better than expected in order to avoid even further de-rating.”
International Monetary Fund Asia head Changyong Rhee warns that potential Fed mistakes could be a clear and present danger. “We are not expecting a US monetary normalization to cause big shocks or large capital outflows in Asia.” But, he adds, “emerging Asia’s recovery may be retarded by the higher global interest rates and leverages.”
There’s a risk, too, that having delayed action against inflation, the Powell Fed could easily bumble into a policy error that upends Asia’s 2022.
“The first policy mistake was completely misunderstanding inflation,” says Mohamed El-Erian, economic adviser at Allianz. The Fed, he adds, has “maintained its transitory inflation narrative for 2021 way too long, missing window after window to slowly ease its foot off the stimulus accelerator.”
The longer the Fed leaves its foot on the gas, the greater the risk Asia might go off the road with Team Powell if the most powerful central bank loses control.
Follow William Pesek on Twitter at @WilliamPesek