Via the excellent Damien Boey at Credit Suisse:
On Friday evening, we learnt from leading central bankers that the world is not experiencing a mid-cycle slowdown. Rather, it could be on the cusp of a regime shift in global monetary policy.
Equities were extremely weak and volatile, while the yield curve inverted dramatically further amid US-China trade war escalation, dovish omissions from Fed Chair Powell, and bizarre comments from Bank of England Governor Carney about the need to replace the USD as a “reserve currency”:
- Initially, equities sold off on the announcement of trade war retaliation from China. Specifically, China announced that it will impose 5-10% additional tariffs on USD 75 billion worth of imported goods from the US.
- Subsequently, equities recovered on Powell’s Jackson Hole remarks. Powell highlighted that while the labour market and consumer spending have been strong, trade war uncertainties were weighing on business spending and sentiment, He hinted that more easing is likely soon, but stopped short of providing longer term guidance. Indeed, Powell omitted his previous reference to a “mid-cycle slowdown”, which could be interpreted as the Fed abandoning its “one and done” approach to cutting, and embracing instead the need for a more protracted easing cycle. Interestingly, Powell suggested that monetary policy could have its limits in the current environment, as it could not provide a settled rule book for international trade.
- In response to these developments, US President Trump raised the question of who was the bigger enemy of the US: Chinese President Xi, or Fed Chair Powell? He went so far as to suggest that the US did not need China, and ordered US companies to immediately start looking for alternatives to China (an apparent reference to an obscure provision in the 1977 International Emergency Economic Powers Act). Trump promised further escalation in the afternoon, which as it turned out, involved more tariffs. He said that the US will raise tariffs to 30% from 25% on USD 250 billion of Chinese goods already being taxed from 1 October, while also threatening to increase tariffs on the remaining USD 300 billion of imported goods to 15% from 10%. Predictably, equities sold off very sharply on these developments.
- Finally, outgoing Bank of England Governor Carney spoke at Jackson Hole, suggesting that the USD’s role as an international reserve currency was exacerbating disinflation and the downside risks from a trade war, that extremely low interest rates had often coincided with financial instability and wars in the past, and that a change in hegemony was inevitable. Specifically, Carney argued that when the USD was chosen as the preferred currency for settling international trade transactions a generation ago, the US economy was very large as a share of the global economy. However, over time, emerging markets economies have become more dominant, but yet, their currencies have not displaced the USD in international trade. Carney suggested that the CNY could become the dominant currency, but still remains some way off. Instead, he proposed that that a digital alternative could and should be created first.
