Why Federal Reserve’s Pause Could Be Another Head Fake


In recent public statements, Chairman Jerome Powell has exuded a distinct “mission accomplished” vibe. This has stock markets from Tokyo to Jakarta giddy at the prospect of U.S. bond yields receding from 17-year highs.

Not so fast, warn economists at Deutsche Bank. They list no fewer than six episodes over the last two years when markets assumed the Fed’s rate hike cycle was ending—but only got interest rate hikes to continue.

The episodes in question: the Omicron Covid variant scare of November 2021; Russia’s Ukraine invasion in Spring 2022; fallout from China’s pandemic lockdowns; global recession fears in July 2022; England’s debt chaos in Fall 2022; the Silicon Valley Bank panic of March 2023.

Wrong at every turn as the Powell Fed kept on hitting the monetary brakes. Might the financial intelligencia be proven wrong again this time? It’s entirely possible given the difficulty the Fed is likely to have getting inflation down toward 2%.

“As inflation begins falling, the debate increasingly turns to the risk of over-tightening, and whether policy risks being too restrictive,” Deutsche Bank argues. “It’s difficult to know the answer in real time since monetary policy operates with a lag. So, with markets pricing a pivot for a 7th time, it’s worth considering whether the conditions are actually in place for that to happen.”

Those conditions include the Israel-Hamas crisis precipitating a broader conflict in the Middle East that sends oil prices skyrocketing. Or Russian leader Vladimir Putin intensifying attacks in Ukraine, which could boost both energy and food costs. And despite the kumbaya moment U.S. President Joe Biden and Chinese leader Xi Jinping shared in San Francisco last week, the threat of increased trade brawling hovers over 2024.

Just about the only thing on which Biden’s Democratic Party and the Republicans loyal to former President Donald Trump can agree upon is the need to obstruct China’s path to global dominance. The lead-up to the November 2024 election could be littered with additional sanctions that upend supply chains anew, fanning global inflation.

Any of these imponderables would keep this 7th pivot to a Fed-is-finished crouch from being the charm for Asian markets. This region, remember, has a very uneasy relationship with aggressive Fed tightening cycles.

Here, the Fed “taper tantrum” of 2013 comes to mind. But the real bookend is the 1994-1995 period, the last time the Fed tightened as aggressively as it has over the last two years.

Back then, the Fed, led by Alan Greenspan, doubled short-term interest rates in just 12 months. The campaign didn’t just shake global markets—it racked up a number of headline-grabbing casualties. Mexico’s peso crisis, the bankruptcy of Orange County, California and the demise of all Wall Street securities giant Kidder, Peabody & Co. were all pinned on the Greenspan Fed.

The collateral damage eventually arrived in Asia. By 1997, a powerful multi-year rally in the dollar made currency pegs impossible to maintain. The chaos from Thailand’s devaluation in July 1997 quickly spread to Indonesia and South Korea. It pushed Malaysia and the Philippines to the brink. It had global trading pits worried Japan and China might stumble, too.

In November 1997, Japan nearly obliged when Yamaichi Securities collapsed. The failure of a then-100-year-old Japan Inc. icon panicked investors everywhere. It also had economists worried about China hitting a wall. The fear was that China might devalue, kicking off fresh waves of market turbulence. Thankfully, Beijing didn’t.

The worry today is that the Powell Fed might continue hitting the brakes in ways that imperil Asia anew.

The good news: minutes of the Fed’s November 1 policy meeting suggest that it might require upside inflation surprises to get the Fed to tighten in the weeks ahead. “Participants,” the Fed says, “noted that further tightening of monetary policy would be appropriate if incoming information indicated that progress toward the Committee’s inflation objective was insufficient.”

Yet global conditions might not cooperate. This explains why Fed board members remain, using Powell’s word, “careful” about declaring victory versus inflation prematurely.

As Powell put it earlier this month: “Inflation has given us a few head fakes. If it becomes appropriate to tighten policy further, we will not hesitate to do so. We will continue to move carefully, however, allowing us to address both the risk of being misled by a few good months of data, and the risk of over-tightening.”

Deutsche Bank can think of at least six reasons why Asia shouldn’t believe the hype that the Fed’s inflation fight is over. The last quarter century is littered with cautionary tales suggesting more Fed pain could be on the way.


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