By PIERRE VEYRET
MANY investors and analysts were caught by surprise after last week’s ‘No-Event’ from the Federal Reserve’s Open Market Committee (FOMC) meeting. The Fed’s chairman, Jerome Powell, only came with words rather than actions at last Wednesday’s press conference, where he announced the FOMC did not make any changes to short-term interest rates, even though this had been widely expected. This obviously disappointed stock investors almost everywhere, leading to an extended sell-off on riskier assets while the US dollar and bond markets jumped.
Why would investors welcome a more “hawkish” approach from the Federal Reserve? Why did the FOMC fail to deliver, and what does it really mean? Here are a few answers.
Markets, investors, and the Federal Reserve
As a reminder, the Federal Reserve’s main objectives are:
Moderate long-term interest rates
Price stability (2 percent inflation)
After almost two years of unprecedented artificial support, through its massive bond buying programme set up to protect the US economy against the impact of COVID-19, inflation is now currently sitting at an outstanding 7 percent.
With such rising price pressures, most investors started to anticipate a “hawkish” switch in terms of monetary policies as the Federal Reserve sought to tackle inflation rates that are taking off, far away from the 2 percent target. Under normal circumstances, a more aggressive approach from a central bank regarding monetary tightening should put pressure on riskier assets, such as stocks.
However, the fact the Federal Reserve did not act this week has been perceived as a lack of efficiency for an institution who even first qualified, wrongly, rising prices as “transitory”. The extended sell-off on stock markets can then be qualified as a vote of “no confidence” from investors to the Federal Reserve, which has highlighted how economic conditions were improving in the US.
Is the US Economy really booming?
This is where the trick is. While many financial media and institutions advised their clients and audience on how the US economy is performing well, actual figures are telling another story.
Let us begin with the so-called ‘strong and tight’ labour market. It is true that general unemployment has been constantly dropping in 2021. The numbers show the US came from 6.4 percent to 3.9 percent unemployment over the past year (chart above).
However, to get a clearer idea of the health of the labour market, this number has to be placed in front of the non-farm payroll, which measures the real dynamics of the private sector - the most important sector in the US. This number has been significantly decreasing since July 2021, meaning there is less and less job creation other than farm and government workers, which is a sign of slower economic growth (chart below).
Talking about economic growth, a quick look at the US GDP chart could quickly convince anyone the US economy is doing well. These numbers show the speed at which the economy expands, and we can see the US has been registering slow but solid growth over the past few quarters with 6.9 percent for the 2021 fourth quarter (chart below).
However, the real efficiency of the US economy can only be measured when government debt is considered. That said, the US government debt-to-GDP chart (below) provides us with a much better idea on how GDP should perform to match the federal debt, and it is not a happy tale. The pandemic and massive bond buying programme by the Federal Reserve have taken this debt number to an unbelievable 128.10 percent of the country’s GDP.
This is the real deal for the US economy.
The Federal Reserve is in a tricky position now, as it seems its short-term solution to protect the economy against COVID-19 is likely to cause even bigger longer-term problems for growth.
The Federal Reserve absolutely needs to take “hawkish” measures in order to tackle inflation, but also has to remain “dovish” enough to keep supporting an economy under strain due to the outstanding debt it bought in the first place.
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