Central Banks' Coordinated Dance: Will the Balancing Act Prevent Economic Collapse?
Abraham George Macro Musings
The media buzzes with discussions of de-dollarization and a reversal in outsourcing, yet behind the scenes, major central banks work closely together to ensure market stability.
The process of normalizing interest rates has been a highly coordinated effort thus far. Short-term interest rates stand at 5% in both the UK and the US, despite the UK grappling with a more severe inflation problem. Surprisingly, even with the recent 50-basis-point hike in the UK, the 10-year rates moved lower instead of higher.
To their credit, the central banks have managed to fulfill their duties thus far. However, whether they will maintain control of the situation going forward remains uncertain. In the face of extreme hostility and intricate financial, economic, and political challenges, the bond markets have admirably maintained their composure.
As I have previously emphasized in my articles, the central banks are determined to fix and manipulate the situation to uphold market stability. We can witness a prime example of this in the Silicon Valley banks. They operate without clear rules or guidelines, adapting their approach to suit the demands of the situation. However, Treasury Secretary Janet Yellen's recent testimony before Congress did little to inspire confidence. Either she lacks awareness of many concerning issues or she deliberately avoids discussing them.
Central bank cooperation holds the key to everything, at least until that bond is broken. We must adapt our strategies accordingly, for no one has ever profited by betting on the end of the world.
The collaboration among central banks has yielded stability in the foreign exchange, equity, and bond markets. The tightening efforts of the Western world have been offset by the injection of liquidity from Japan. Japan, burdened with a structural deflation problem and the world's largest government debt, remains a crucial player in this equation.
Wall Street bankers have woefully misunderstood these markets. It is possible that their true positions were contrary to the narratives they conveyed to retailers.
How is it that the S&P 500 sits merely 10% below its all-time high while interest rates have surged from 0% to 5.25% at an unprecedented pace in the history of the Federal Reserve?
There is a limit to how much the Fed will raise rates. It appears their objective is to push fed funds above a 2% inflation rate. At present, inflation stands at 4%, and fed funds are at 5.25%. Consequently, Powell maintains his narrative of further rate hikes. However, the truth is that inflation is currently receding, and at some point, the policy will become overly restrictive. The Fed's relentless focus on the labor market has not yielded the desired outcomes.
On Friday, we will receive the May core PCE, the Federal Reserve's preferred inflation measure. A dynamic of positive real interest rates exerts downward pressure on inflation. Positive real interest rates are desirable as they prevent the formation of bubbles and deter significant misallocation of capital. Hence, we await Powell's response and actions if inflation continues to decline.
In my view, the dynamics are aligning for further fragmentation in equity markets and an increase in bond prices.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office, and a hedge fund.