Pedalling harder just as the brakes are being applied
My brother-in-law is a cycling fanatic. I asked him the other day if there is a technical term to describe pedalling while the brakes are being applied. He thought about this for a moment, before suggesting "stupidity".
- the monetary policy cycle seems completely out of sync with the actions of politicians
- politicians are pushing demand into the system as central bankers are draining liquidity
- this presents a real risk for fixed income markets
It is almost 10 years since the financial crisis and the long drawn out recovery finally appears to be on a self-sustaining path. Monetary policy is gradually being tightened in the US, emergency rate cuts are being reversed in the UK and the ECB is dialling down its QE programme. With US unemployment just hovering above 4%, many monetary hawks will be thinking this is not before time.
Yet the monetary policy cycle seems completely out of sync with what politicians are up to. The White House's self-certified genius has pressed forward with massive personal and corporate tax cuts, Philip Hammond has been forced to ease his austerity drive in the face of Corbyn's populism. Even in Europe, Merkel may be obliged to concede to more spending in order to form a working government. In recent days it has emerged that a package of spending worth the equivalent of 1.2% of GDP may be the cost to gain support of the SPD in order to form a coalition. These are all policies that push demand into the system, just at a time when central bankers seem eager to drain liquidity from the system.
Such a mismatch between monetary and fiscal policy is not without precedent but that doesn't make it any more sensible. Presumably once the fiscal splurge gets underway, central banks will act by ramping up interest rates, possibly far quicker than markets currently discount. This presents a real risk for fixed income markets and could place equity valuations under pressure. Higher rates of course can lift the attractions of a currency. So, perversely, once markets had gotten over the shock of say, a Corbyn premiership, sterling could end up being stronger - compounding the damage that his policies might bring to the economy. Now that really sounds a stupid idea.
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