Alex Sebastian: we’re at the start of a long journey to higher rates

The road to higher interest rates on both sides of the Atlantic is going to be a long one, but the journey along it begins with the Jackson Hole symposium.

As America’s central bankers meet for the ‘virtual’ Jackson Hole symposium we are approaching the beginning of a long, slow journey to rising interest rates.

As with many things, America will lead the way into some form of policy normalisation and Britain may not be far behind.

Without saying anything particularly hawkish or making any firm commitments, Jerome Powell’s Jackson Hole speech is expected to gently lay some groundwork for a meaningful change in policy at the 21-22 September Federal Reserve meeting.

Whether it happens next month, or in October or November, ‘tapering’ (winding down) of the Fed’s colossal bond buying programme - $120 billion a month currently - is nearing, bar any dramatic change of course in the fading pandemic.

It’s going to be a long road to rate rises though, as the Federal Reserve’s current policy is to get tapering well under way before hikes are on the table.

Powell and colleagues have gone as far as to say tapering does not necessarily mean rate rises are coming at all, but few are buying this line.

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Markets price policy changes in well before they happen, so even if actual rises are a year or more away, it will impact share prices much sooner.

Increasing numbers of experts are now warning of a correction in the stock market as this reality dawns on investors. There is, of course ,clear precedent for this in the form of 2013’s ‘Taper Tantrum.’ While it is unlikely to mirror that exactly, it is a useful yardstick on what we can expect.

Markets are ready for a pullback after the stellar run seen since March 2020 as investors piled into the market after the pandemic inspired plunge. There have been a few dips along the way, but if you just zoom out on your chart it’s one big uptrend since then.

With the stock market, big dips can come along simply because enough people believe one is due, regardless of whether anything has fundamentally changed.

Nobody who pays any attention to such things will be surprised when the Fed formally announces the start of tapering its QE programme, as it is being telegraphed well in advance.

That doesn’t mean it won’t shake the market though, due to people being primed to hit the sell button when they think the time is right, and cash in on some of their juicy gains.

While moving too quickly or dramatically goes against everything the modern day Federal Reserve has come to represent, there is plenty of danger in moving too little or too late.

Shutting the monetary policy stable door after the inflation horse has bolted is the one thing that is most important to avoid in central banking.

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US inflation has topped 5%, which is more than double the 2% target. The ‘transitory’ claim can only hold water for so long.

Inflationary pressures continue to build, not least due to a tightening US labour market, with unemployment now squeezed down to 5.4%.

There’s a cautionary tale being written to the south right now, in the form of Brazil. Of course, it’s a very different country and situation, but inflation is getting away from policymakers there and has reached nearly 9%.

This is the sort of level that risks seriously destabilising a nation’s economy, and sending investors running for the hills.

Once inflation hits that sort of number there is the risk of a dangerous spiral. People rush to buy things in fear they will get more expensive and workers demand wage rises, thereby exacerbating the price climbs.

Even in a best-case scenario, where inflation at this level can belatedly be reined-in, it requires heavy-handed intervention from the central bank. The rate spikes required bring their own problems.

This could have serious implications for emerging markets, with Brazil an important component of the asset class. The ‘B’ in the now outdated BRICS acronym.

Such a scenario remains unlikely in the US, but Powell and his colleagues will be acutely aware that the time to act is near.

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