President Trump repeated his same message, demanding action from Jay Powell and The Fed:

“As usual, Jay Powell and the Federal Reserve are slow to act. Germany and others are pumping money into their economies. Other Central Banks are much more aggressive. The U.S. should have, for all of the right reasons, the lowest Rate. We don’t, putting us at a competitive disadvantage. We should be leading, not following!”

But, Mizhuho rates strategist, Peter Chatwell, is concerned that The Fed will ‘deliver’ what Trump and the market is demanding, sending it even deeper into a liquidty trap…

Dear Fed,

On Friday you gave yourself the option to ease and provided a bit of calm to the stock market. It won’t work. Don’t make the mistakes the BoJ and ECB have made in trying to paper over structural problems with liquidity. If you do, your actions will be deflationary and you will devalue your monetary tools. Your real structural problems are rising inequality and the number of ‘zombie’ companies.

The virus will have a major economic impact. Global growth may fall on par with the GFC. It will, with a lag of 6-9 months, justify you easing through the employment dimension of your mandate. It will not, however, be disinflationary. Getting Fed Funds down to 1.25% would put your monetary policy back to a slightly accommodative setting.

However, moving too early, in order to support confidence (let’s admit it, stocks), will put you in a currency war you cannot win. Other central banks, who are missing their inflation targets will follow swiftly, reducing the FX benefit of your easing. By moving to support “confidence” (stocks) and “transmission” (spreads) you will in fact be generating deflationary forces.

Your easing since the GFC has allowed zombie companies to continue their lumbering, groaning, slow-motion takeover of the economy. By no means are we saying you need to shoot them (hike), but equally don’t support them just to satisfy your urges for a roaring SPX. Instead society needs them to bow out gracefully (let PE take the risk). Equities will perform better in the long run if you let the zombies die.

By cutting rates on March 18th, you will be telling the market a) that, all else equal, the underlying value from this level is dubious, and b) that you are determined to support asset bubbles. You will be advocating leveraged longs of failing companies. Your rate cuts will reduce the neutral Fed Funds rate once again. You are choosing to dive into a liquidity trap, racing to 0% Fed Funds and a QE restart. Yield curve control (another market vol killer) should also be avoided. Please learn the lessons from your international counterparts. The water in the liquidity trap isn’t lovely, don’t dive in!

Your attempt to change your inflation target becomes all the less credible in a liquidity trap. Instead of hitting the new target, you will be stuck answering the academic paradox of the reversal rate. As the central bank of the world’s largest economy, you set the tone for other central banks. Forcing them closer to their own reversal rates in this arms race is irresponsible, undermining fiat currency purely to attempt to put a base into equities.

Yours sincerely,

A concerned strategist.



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