Aurelia Butler

As central bankers from around the world descend on Jackson Hole, Wyoming, for the first in-person annual conference since 2019, Federal Reserve chair Jay Powell will face something that was largely absent during the past two virtual meetings: a tough crowd.Celebrated two years ago for rescuing the global economy and financial system from a catastrophic pandemic-induced crash, the US central bank has since faltered, initially misdiagnosing what has become the most acute inflation problem in four decades and then being forced to play catch-up.As a result, Powell, who was reappointed to a second term in November, is under immense pressure to execute a historically difficult task: fine-tune monetary policy to safeguard the Fed’s inflation-fighting credentials without causing more job losses than necessary. “This is not a great period for the Fed right now, not just because the challenges are tremendous, but I think the Fed has also made some missteps,” said Ellen Meade, who served as a senior adviser to the central bank’s board of governors until 2021.“Powell wants to do the right thing, and he’s not out there to make a mistake,” said Meade, who is now a professor at Duke University. “But if he loses this one, this is the whole ball game.”The Fed has already embarked on the most aggressive campaign to raise interest rates since 1981 and is expected to take further action throughout at least the second half of 2022. Central banks across advanced and emerging economies have followed suit, grappling with their own inflation surges exacerbated by Russia’s invasion of Ukraine.But former officials and economists warn that another big test of the Fed’s credibility will emerge in the next phase of tightening, when inflation has not yet slowed sufficiently but the economy starts to flash more obvious signs of weakness. Jay Powell, left, with the then Bank of England governor Mark Carney at the Jackson Hole economic symposium in 2019 © Amber Baesler/APPowell, whose legacy will depend in large part on the outcome, must build consensus across what is likely to become a more divided central bank.The Fed’s predicament stems from its early assessment that the consumer price surge triggered by supply chain disruption and trillions of dollars of pandemic-related fiscal stimulus was temporary. It was a view shared by most but not all economists to begin with, and one that Powell devoted the entirety of last year’s Jackson Hole speech to supporting.Distorted data had concealed the strength of the labour market, which is now one of the tightest in history.Viewing inflation through a “transitory” lens — a term Powell officially abandoned in November — laid the basis for a series of policy blunders that led to the Fed expanding its balance sheet long after additional support was no longer necessary. It also waited until March before raising rates.“We should have recognised last fall that this was a time to slip monetary policy on to the correct path,” said Randy Quarles, the Fed’s former vice-chair for supervision who left in late 2021. “Had we responded earlier, inflation would not have reached the level it is at now.”The central bank was too wedded to the idea that “you can’t step on the gas and the brake pedal at the same time”, said Quarles, meaning officials felt obliged to hold off raising rates until they had stopped hoovering up Treasuries and agency mortgage-backed securities. Others thought the Fed should have started to “taper” its bond purchases sooner. Quarles, who now foresees the federal funds rate rising as high as 4 per cent and a “short and shallow” recession next year, said an interest rate increase as early as November would have been appropriate.

Powell also admitted last month that the guidance the central bank had provided in late 2020, in which it laid out the economic milestones that needed to be reached before it would stop easing policy, was too inflexible for an environment of such extreme uncertainty.“I don’t think that that has materially changed the situation, but I have to admit, I don’t think I would do that again,” he said.Heading into this year’s Jackson Hole conference, economists say the Fed has tried to correct many of its earlier mistakes, having “front-loaded” its interest rate increases and raised the benchmark policy rate from near-zero to a target range of 2.25 per cent to 2.50 per cent in just four months.Most officials now expect rates to rise by at least another percentage point by the end of the year, with a third consecutive 0.75 percentage point rate increase under consideration for the September meeting. But concerns linger about the Fed’s resolve to continue squeezing the economy if unemployment climbs higher than expected. The other risk is that inflation is far harder to root out than is currently anticipated. The fear is a redux of the 1970s, when the Fed oscillated between raising rates to stem price pressures and cutting them to prop up growth, failing to get inflation under control in the process. The central bank then had to slam on the brakes more forcefully, causing a far worse economic contraction than otherwise would have been the case.“The bigger risk is that they reverse course too soon, not that they tighten for too long,” said Charles Plosser, who served as president of the Philadelphia Fed from 2006 to 2015. “The concern has to be, will they stick to their guns? Will they provide enough of a slowdown to actually bring inflation down, keep it down and restore the Fed’s credibility?”

While the Fed has framed its commitment to price stability as “unconditional”, officials — unlike most Wall Street economists — maintain that a recession is not a foregone conclusion.At their most recent policy meeting, they also discussed nascent signs the economy is cooling and the risks of being heavy-handed with tightening, fanning fears that a more divided Fed will back off its inflation fight prematurely.On Friday, Powell is set to underscore the central bank’s commitment to do what is needed to combat inflation, even if it determines it may soon be appropriate for the Fed to start implementing smaller rate rises.“The Fed at this point cannot lose control of the narrative,” said Claudia Sahm, founder of Sahm Consulting and a former Fed economist. “They need to make really clear that they understand what the stakes are [and] what the potential very negative consequences of the path that they have set themselves on are.” More

Banks have waited years for higher interest rates to revive their fortunes. But in the UK, where markets predict interest rates will hit 4 per cent by May, taxpayers could end up contributing via the Bank of England.This would play badly with voters during a cost of living crisis. The government and the BoE might therefore stop paying interest to banks on the so-called “reserves” created during quantitative easing.QE converted long-term government liabilities into overnight borrowing. The BoE bought £847bn of gilts, financed with the new “interest-paying reserves”. The interest paid by the central bank has been at a lower rate than the coupon payments it receives on the gilts. That has allowed it to hand the Treasury a cumulative profit of £123bn to the end of April. But once interest rates rise above 2 per cent, that cash flow will turn negative. The left-of-centre think-tank New Economics Foundation has put the UK bill at up to £57bn over the next three years. The UK is in a tight spot because its vast amount of index-linked debt, nearly a quarter of the whole, is forecast to more than triple debt interest spending to £83bn in the two years to next April. A further sustained one percentage point increase in interest rates and inflation would cost an additional £18.6bn the following year. Going back to paying no interest on reserves would help ease the pain. The dire state of public finances will make it tempting for the government to rewrite the rules so the reserves — or at least a big part of them — carry no interest. Advocates point out that paying no interest on reserves was the norm before the financial crisis. Even so, the rule change would be equivalent to imposing higher tax on banks. The obscure nature of the implicit levy will appeal to politicians who like to find ways to pluck feathers from geese with minimal hissing. It is a subtler way of transferring money from banks to the government than Spain’s €1.5bn annual windfall tax. Hungary has imposed a similar levyPoliticians would not care that saddling commercial banks with a non-interest-bearing asset would make them even less attractive to investors. But they should weigh up the totality of disadvantages. Making commercial banks less competitive would increase flows to shadow banks. That would create new risks to financial stability. More

Investing.com — Europe’s energy crisis is becoming an industrial crisis. The U.S. releases revised second quarter GDP figures and – more up-to-date – weekly jobless claims. China’s government tops up its stimulus package and Nvidia is hit by a new reduction to its sales guidance. Here’s what you need to know in financial markets on Thursday, 25th August.1. Europe’s energy crisis won’t endEurope’s energy crisis is turning into an industrial crisis. Last week, some of the biggest zinc and aluminum smelters on the continent shut down due to high power prices. This week, the latest surge in gas prices has forced fertilizer makers in Norway, the U.K., and Poland to idle capacity, unable to pass those prices on to their farming customer base.A shortage of fertilizers threatens to put downward pressure on crop yields next year, which will keep food prices higher than they would have been otherwise.Benchmark European gas prices topped 300 euros a megawatt-hour earlier Thursday. At those levels, Germany – Europe’s largest economy – would have to spend over 8% of its GDP to sustain its gas habit. German GDP eked out a 0.1% gain in the second quarter but Ifo’s monthly business survey confirmed it’s on track for a drop of around 0.5% in the current quarter.To make matters worse, Électricité de France (EPA:EDF) said it would have to delay the restart of several reactors which have been closed for maintenance this year, prolonging the squeeze on electricity prices.2. Jobless claims, GDP revision due; Bostic warns of possible 75 bp hikeThe U.S. will release revised figures for second quarter gross domestic product at 08:30 ET, with analysts expecting a small upward revision that will do little to change the broader narrative of an economy being deliberately slowed down by tighter monetary policy. The price components of the data are likewise too far in the past to affect the current outlook meaningfully.Of more interest will be the weekly jobless claims numbers, whose surprising strength last week supported arguments that the economy can withstand higher interest rates easily enough.The market remains focused on Federal Reserve Chair Jerome Powell’s keynote speech at Jackson Hole on Friday, amid expectations that the next interest rate hike will be only 50 basis points, after two successive 75 bp hikes. Atlanta Fed President Raphael Bostic, however, told The Wall Street Journal in an interview that a 75 basis point increase may be appropriate if the economic data stay strong.3. Stocks set to build on modest gains; Nvidia hit by sales warningU.S. stock markets are set to open higher again, building on Wednesday’s moderate gains, helped by the positive outlook from software group Snowflake (NYSE:SNOW) late on Thursday. Enterprise software makers tend to be seen as proxies for business investment, which appears to be holding up better than feared. Workday (NASDAQ:WDAY), another company in that segment, reports after hours.By 06:15 ET (10:15 GMT), Dow Jones futures were up 86 points, or 0.3%, while S&P 500 futures were up 0.5% and Nasdaq 100 futures were up 0.6%.The Nasdaq’s bounce was all the more conspicuous given the disappointment from chipmaker Nvidia (NASDAQ:NVDA), which again cut its outlook on Thursday due largely to the slowdown in demand for gaming chips. Nvidia expects sales in the current quarter to be down 17% on the year.Elsewhere, discount stores Dollar Tree (NASDAQ:DLTR) and Dollar General (NYSE:DG) will report results, casting light on how much pressure inflation is putting on them and their customers.4. China stimulates, Korea tightensThe Chinese government topped up its economic stimulus to 1 trillion yuan (around $150 billion), trying to restore an economy ravaged by drought and COVID-19 restrictions.The 19-point plan released by the State Council focused largely on debt-financed infrastructure spending, a strategy that has shown diminishing returns as the real estate sector buckles under its enormous debt load. Chinese stocks reacted with modest gains, while Chinese bond yields rose, pulling the yuan up from the two-year low that it hit against the dollar on Wednesday.China is heading in the opposite direction on policy to most of the rest of the world. Elsewhere overnight, the Bank of Korea raised its key rate again, by 25 basis points to 2.5%. The won, which fell to a 13-year low against the dollar on Tuesday, strengthened by 0.4%.5. Oil lifted by China measures, U.S. inventoriesCrude oil prices touched a three-week high overnight as the Chinese stimulus package lent support to the global demand outlook. Prices were also supported after the U.S. government confirmed a bigger than expected drop in crude inventories last week.The usual seasonal bid from the approach of the U.S. hurricane season is also starting to loom.By 06:30 ET, U.S. crude futures were up 0.1% at $94.98 a barrel, while Brent crude was up 0.3% at $101.52 a barrel. Natural gas futures, which were driven to 14-year highs earlier this week by LNG demand from Europe, eased a little further to +6%. More