Wednesday’s double-barrelled attack on inflation may fall short as markets gyrate

0
97


While Canadians wait to see whether interest rates really will begin to rise tomorrow, it might be reasonable to ask what all the fuss is about.

As a friend commented last week, when we were discussing the double-barrelled pronouncements on inflation and interest rates from both Ottawa and Washington coming Wednesday, a quarter-point increase on interest rates doesn’t really seem like much of a difference.

But after markets were taken on a wild ride Monday, coming after what had already been the worst week in more than a year, you have to ask yourself why traders seem so nervous.

What’s the effect on me?

And to bring it home to heavily borrowed Canadians: What impact will the mere threat of a small rate raise have on me?

Those dubious of the importance of a tiny increase in interest on things like the housing market might also ask why Bank of Canada governor Tiff Macklem and his counterpart at the U.S. Federal Reserve, Jerome Powell, have been so reluctant to actually pull the trigger and raise rates.

Despite haywire markets, there are many who doubt interest rates will rise tomorrow, when those central bankers both hold monetary policy announcements.

Most commentary seems to suggest Powell will put off making a move on rates at least until spring. And those who trade in interest rate futures, making predictive bets on such things, imply there is only a five per cent chance the Fed will alter rates currently near zero at tomorrow’s meeting.

Bank of Canada governor Tiff Macklem speaks during a news conference in Ottawa on Oct. 27, 2021. (Adrian Wyld/The Canadian Press)

Macklem may have reasons of his own to delay a move that would make Canadian exports more expensive in our biggest markets. Those same predictive markets that saw a 75 per cent chance of a hike last week — when inflation rose to 4.8 per cent — have scaled back their outlook to 63 per cent. Expect another re-evaluation after Monday’s wild ride.

But whether or not the central bankers act on Wednesday, or bide their time once again, the question remains: Why are small changes in interest rates so powerful?

The question applies not just when rates are about to rise, but also when the cost of borrowing is falling, even if being artificially held down by most of the world’s central banks.

Lords of easy money?

It also comes as a new book titled The Lords of Easy Money: How the Federal Reserve broke the American Economy is grabbing lots of attention in the financial press; it’s about a central banking voice-in-the-wilderness who warned that the repeated use of low interest rates to keep stimulating the economy would eventually have dire consequences.

The book profiles Thomas Hoenig, an otherwise straight-laced, conservative president of the Kansas Fed, one of the regional reserve banks that collectively make up the U.S. Federal Reserve system.

As the book’s author, financial journalist Christopher Leonard, writes, Hoenig worried that endless low rates linked to the Fed’s quantitative-easing policy would be the opposite of Robin Hood: They would give to the rich in a huge financial bubble, while robbing the poor and middle class.

And he worried that eventually it would all come crashing down.

A European trader reacts to falling markets during a previous downturn. Just the implied threat of more expensive money has thrown markets into a tizzy. (Olivia Harris/Reuters)

“He believed that this money would widen the gap between the very rich and everybody else,” Leonard writes. “Just as important, this tidal wave of money would encourage every entity on Wall Street to adopt riskier and riskier behaviour and a world of cheap debt and heavy lending, potentially creating exactly the kind of ruinous financial bubble that caused the global financial crisis in the first place.”

Reading those sentences this week following the latest market chaos sends shivers up the spine.

While most central bankers have repeatedly insisted the cause of inflation has not been low rates, but rather shipping bottlenecks and a new consumer urge to spend, many others, including Scotiabank economist Derek Holt, say low rates cannot be ignored as they relate to this current round of rising prices.

“A contributor to that is the fact that we had generational lows in interest rates, as monetary policy, partially with the benefit of hindsight, turned out to do a little bit too much in cutting interest rates,” Holt told the CBC following last week’s release of the inflation rate.

Mass psychology

Inflation, based on human mass psychology, is not a simple mechanical process. As people who research the actions central banks have explained in the past, in some ways, setting interest rates is a way of managing people’s beliefs about the value of money.

Despite the fact that the U.S. central banks dumped more than $1 trillion into the economy between 2008 and 2010 — and have since then made it virtually free for banks to borrow — the world continued to believe their money was just as valuable as it had been before.

As University of Alberta economist Constance Smith once told me, a money glut can take years to work through the system, waiting for a trigger.

WATCH | Inflation rate hits 30-year high:

Inflation rate hits 30-year high

The rate of inflation has hit its highest point in nearly 30 years, with the cost of groceries seeing the biggest annual increase in a decade. Interest rates are expected to rise soon, but it won’t be a quick fix. 1:59

Also, the actions of a central bank can have perverse effects. After a year of central banks insisting inflation is either not coming at all, and then saying it will be brief and transitory, a move to hike rates to slam on the brakes may convince consumers and businesses that inflation is real and something to worry about.

And with so many faulty signals in the past, borrowers and investors can’t be sure when interest rates will stop rising once they start.

The change from falling rates to rising rates has always been a difficult time. Falling rates make everything easy for investors and consumers. They make bonds and houses rise in value. They tend to make stocks go up. Falling rates make it cheaper to borrow to buy or build new homes. They make it easier for governments to borrow and spend.

Rising rates, if they eventually come, will have the opposite effect, slowing the entire world economy — and making everyone feel poorer in the process.

So that measly quarter-point increase — if that’s where it stops — is not just on you and your loans and investments, but on other people’s too, making everything just a little bit harder for everyone all at once.


Follow Don on Twitter @don_pittis





Source link

LEAVE A REPLY

Please enter your comment!
Please enter your name here