Why no news from the Fed is good news

He said growth remained strong, and price pressures were under 3 per cent. “I dont see the ‘stag,’ I don’t see the ‘flation’,” he said.

Powell, by avoiding any meaningful discussion about rate hikes and talking down the prospect of stagflation, effectively kept open the prospect of one or more rate cuts that markets still believe are possible this year, even though that prospect keeps being pushed back towards the end of the year.

Essentially, he was saying that the rate cuts anticipated by the markets and the Fed itself this year (the bank has three in its latest projections) have been delayed rather than abandoned. For investors, that message is far more palatable than the alternative that they feared.

But the “higher for longer” scenario the Fed expects provides no relief for its central banking peers who have been grappling with the strength of the US dollar even as their economic fortunes have diverged from America’s.

Japan provides the starkest illustration of how relatively high US interest rates affect other economies.

The yen has crashed to its lowest levels against the US dollar in 34 years. There were unconfirmed reports last week that the Bank of Japan has been forced to intervene and buy dollars to try to arrest the decline in the yen.

The US dollar has appreciated nearly 5 per cent against those of its major trading partners since late December.Credit: Bloomberg

The central bank may have to raise Japan’s modest interest rates to prevent significant capital outflows which would also impact a domestic inflation rate that, after decades of economic stagnation, has finally ticked up.

Modest inflation is better than the growth-flattening deflation Japan has experienced. US monetary policy is, therefore, countering the BoJ’s own strategies even as the Japanese central bank is on the verge of success.

The US dollar has appreciated nearly 5 per cent against those of its major trading partners since late December (the Australian dollar has depreciated by about 4.6 per cent against the greenback over that same period) – which, to some degree, at least, constrains their monetary policies.

The European Central Bank, for instance, is on the verge of cutting its interest rates because of the weakened state of the European economies but risks currency depreciation, capital outflows and a rekindling of inflation as the cost of imports rises if its rates diverge too far from the US settings.

The impact is even greater on developing economies with significant US-dollar-denominated debt, which becomes more expensive to service even as their exports generate less income.

The “higher for longer” outlook for US rates therefore isn’t helpful for other economies and their policymakers. But if Powell had suggested there was a realistic prospect that US rates might rise, that would have been even more damaging.

With the Fed leaving the federal funds rate unchanged and little prospect of a rate cut within the next few months, the window of opportunity for rate cuts before the end of the year is narrowing, which will create a growing political dimension to the decisions the Fed makes in the lead-up to the November presidential elections in the US.

Powell dismissed the suggestion that proximity to the election would influence the Fed, saying it was hard enough to get the economics right without taking into account the political implications of its decisions.

“It’s not what we’re hired to do,” he said. “If we start down that road … I don’t know how you stop.”

Any rate cut in the lead-up to the elections will, of course, be characterised by Donald Trump as electoral interference. Trump advisers are developing a plan to let him influence the Fed’s decision-making should he regain the presidency.

For the past two years, the Fed has been executing a “quantitative tightening” program, allowing $US95 billion a month of the Treasury bonds and mortgage-backed securities it bought during the pandemic to help ease financial conditions and lower market interest rates to run off without reinvesting the proceeds.

That withdraws liquidity from the system and, by removing a major buyer from the bond market at a time when the US government debt and fiscal deficits have been blowing out, adds to the pressure on bond yields.

From June, the Fed will reduce the monthly cap on the maturing bonds where the proceeds aren’t reinvested from $US60 billion to $US25 billion. The $US35 billion redemption cap on maturing mortgage-backed securities will remain.

While the move is a technical one aimed at ensuring there is sufficient liquidity in the system for it to function smoothly, a return by the Fed to the market – the US central bank was, until it started the quantitative tightening program, the biggest buyer of Treasuries – will reduce the demand on others.

At the margin, that might take some pressure off market rates that have been influenced by the narrower spread of buyers for the swelling supply of US government debt. It might also be marginally beneficial for equity investors.

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