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Analysis: The ghosts of past crises haunt policymakers and markets

By on July 1, 2021 0

A man points to a computer screen displaying stock information in this illustrative photo taken in Bordeaux, France on March 30, 2016. REUTERS / Regis Duvignau

  • Fed’s hawkish turn highlights risk of early stimulus withdrawal
  • Premature tightening derailed recovery after financial crisis
  • But governments are now focusing on continued support

LONDON, July 1 (Reuters) – A hawkish turn by the Federal Reserve has woken up global markets to the prospect that policymakers may soon begin to withdraw monetary and fiscal stimulus – and the risk of too hasty action that could stifle the economic recovery before it is secured.

Fed officials have put forward expectations for U.S. interest rate hikes to 2023 from 2024 and have opened discussions on how to end bond buying in times of crisis. Read more

Norway could hike rates as early as September, while good New Zealand data has prompted economists to anticipate rate hikes there. Germany’s Jens Weidmann and Austria’s Robert Holzmann this week became the first European Central Bank officials to openly debate the removal of its pandemic emergency stimulus package of € 1.85 trillion (2.2 trillions of dollars). Read more

Investors are starting to be suspicious: Premature monetary tightening to contain inflation after the 2008 global financial crisis hurt growth, forcing central banks to back down.

“It is important to recognize that it is better to keep monetary stimulus in place for too long rather than removing it too soon,” said Guy Miller, chief market strategist at Zurich Insurance Group.

“If inflation accelerates and the economy heats up too much, the ECB will be in a good position to deal with it. If you remove the stimulus too soon, the situation will become very difficult.”

The ECB raised rates in April and July 2011, as a debt crisis raged, only to cut them four months later. Read more

The Fed began to hike rates in 2015, a move many analysts now see as a policy mistake that needlessly stalled the post-crisis recovery. Read more

A Russell Investments poll of fund managers last week showed that 50% of 72 respondents expect the Fed to keep its inflation promise, down about 10 percentage points from the first trimester. They expect inflation and Treasury yields to rise.

“There are parallels to the past and it’s very useful for the markets right now,” said Gerard Fitzpatrick, global head of fixed income at Russell Investments.

“Concerns about the Fed’s very early rise, we are already starting to see the meaning,” he added, noting economic growth and rising inflation.

Key measures of business activity in the United States and Europe are at their highest levels in years. Inflation is also emerging, judging by the latest US inflation rate of 5%. Read more

One concern is that a less accommodating Fed could pave the way for other central banks to follow.

WARNING

But perhaps these are the lessons of withdrawing fiscal stimulus too early that policymakers really need to heed.

The government’s stimulus measures after the financial crisis were weak compared to those triggered after COVID-19. In places like Europe, the stimulus measures were then quickly withdrawn in favor of austerity.

Governments allocated $ 10 trillion for stimulus in just two months last year and for some countries their response as a percentage of GDP was nearly 10 times what it was after 2008, according to McKinsey & Company .

David Riley, chief investment strategist at BlueBay Asset Management, said the mistake after the financial crisis was to cut budget support too soon, leaving central banks with the burden of supporting economies.

He added that central banks were right to start thinking about cutting back the strong monetary stimulus.

“The main concern I have is that this (the decrease) is seen by governments as a sign that they cannot provide more budget support as the monetary policy backstop is removed and they are starting to worry about bond vigilantes, ”he said, referring to investors punishing libertine governments by increasing borrowing costs in bond markets.

“The risk is that we return to austerity too soon.”

A $ 559 billion infrastructure deal in the United States last week was smaller than expected, with strong opposition from Republicans likely to limit plans for further stimulus.

The German elections in September could also be decisive. The ruling conservative Christian Democrats (CDUs), now leading the polls, promise tight public finances, although economists believe Germany will not be able to balance its books anytime soon. Read more

Morgan Stanley’s European economy chief Jacob Nell has said the premature withdrawal of budget support that ECB chief Christine Lagarde has warned against is exactly what the CDU manifesto calls for.

“We think they will negotiate this in the coalition talks after the elections, but you know there is a real risk of a quick return to fiscal consolidation,” he said.

Overall, however, analysts pointed to signs that governments were determined to maintain support: EU fiscal rules were suspended again this year and BofA estimates the US government will spend $ 879 million. per hour in 2021.

While the Bank for International Settlements this week warned in its annual report of the “daunting challenges” ahead for policymakers when they finally seek to normalize politics, for now, the flow of money The central bank’s cheapness gives large economies a chance to finance takeovers at a relatively low cost. . Read more

“Policymakers have learned from their previous mistakes,” said Miller of Zurich.

Reporting by Dhara Ranasinghe and Sujata Rao in London; Additional reporting by Stefano Rebaudo in Milan; Editing by Mark John and Catherine Evans

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