Netease Interview on US Fed Policy

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The Chinese financial news site, Netease, interviewed Gray Rhino & Company CEO Michele Wucker about the implications of US Federal Reserve policies.

Here’s the interview in English:

There was a view that Fed’s interest rate hike process will be reversed in December. But, finally, a tough rate hike was adopted. What is the reason?
The Fed followed through with its rate hike as part of its long-term goal of trying to normalize monetary policy. Many market observers, and the Fed itself, have long worried about unintended consequences of the very loose monetary policy of the past decade. It cited a strong labor market, consumer spending, and strong economic activity. The Fed also is worried that it won’t have enough room to lower rates in the future if there is another emergency like 2008-09. Though that is not going to happen immediately, the chances of another financial crisis not too far in the future are high. Combined, those factors gave the Fed both the confidence that it had the room to lift rates and a sense of urgency in doing so.

How do you understand the game between Trump and Powell? Now, is it a wrong decision that FED did not choose Yellen?
Trump may be wishing that he chose Yellen instead, but I’m not convinced that she would have made a different decision from Powell’s.

As for Powell himself, it’s been interesting to hear him talking about a strong economy over the past several months, not even hinting at possible trouble –as Trump did until recently- but using that story of strength to try to wean the US economy and markets from the influence of quantitative easing. He’s also clearly defending the principle of central bank independence. After Trump’s public attempts to influence Fed policy and prevent a rate hike, I believe Powell –and probably other Fed governors as well– also felt an extra need to demonstrate that Trump could not bully them. Were the Fed to lose its independent status, U.S. investors would revolt. In fact, news that Trump was talking to his advisors about wanting to fire Powell has not helped markets at all. Powell is doing the right thing in not judging his success by the level of stock market indexes. His responsibilities are much bigger than that, and he knows it.

Has FED assessed the possible negative impact of interest rate hikes on the stock market?
I have no doubt that the Fed has thoroughly assessed the possible negative impact of interest rates on the stock market. But price stability in the real economy –not the stock market– is its primary mandate. However, there is a strong argument that when the stock market becomes a giant bubble, at the expense of the real economy, that legitimately is the Fed’s concern. Asset inflation is no less a problem than consumer price inflation.

From the market bottom in March 2009 until this September, stocks rose by nearly 300 percent, not even counting dividend reinvestment which makes that number even higher. GDP growth was around 36 percent from 2009 through 2017. When the market gets that far ahead of the real economy, it’s clear something is not right. After all, stock prices supposedly reflect what investors expect future earnings to be.

More than a year and a half of relatively steady gains is not normal. Many of the smartest people on Wall Street believe that the market has been caught in acts of “irrational exuberance” and that it was overdue for a healthy correction. In fact, shares are still trading at roughly 15 times earnings, which still cannot be called inexpensive.

But the stock market is not falling just because of the interest rate hike. Stocks also are falling because of the increasing instability in the White House, and widening worries –including among donors in the president’s political party- about his poor decision making in general, and especially where the economy is concerned. Business likes certainty and stability, and the White House is creating the opposite.

The Federal Reserve raised interest rate and the U.S stock market plunged. Will the interest rate hike reverse the momentum of the U.S. economy?
The interest rate hike certainly will slow the economy, but not by anywhere near as much as the impact on the stock market. The big problem with quantitative easing is that the vast majority of the expanded money supply did not go into the real economy -it went into creating huge market bubbles. So money leaving the stock market does not necessarily translate into a comparable amount of money leaving the economy. Also, only about half of the U.S. population have investments in the stock market — 80 percent of stocks are held by the richest 10 percent of Americans. Because they already have so much more disposable income than they can spend, the richest people are less likely to change their consumption behavior than are the rest of Americans. Any impact would likely fall first on very high-end real estate and luxury goods, and then on the broader housing market and expensive purchases like cars or travel.

It’s important to understand that the US and China deal with monetary policy and potential financial risks differently. For example, the United States emphasizes very broad monetary policies –such as interest rate hikes and the Fed balance sheet– and lets markets sort out the rest. Policy makers tend to wait for a crisis in parts of the economy before taking action, as we saw with subprime loans in the 2008 crisis and many people think will happen with collateralized loan obligations now. But China has been taking a much more surgical approach toward specific danger areas, for example, wealth management and peer-to-peer lending.

So it’s important to look at how the US interest rate hike could be creating pressure on specific parts of the economy where rising interest rates can reveal problems that are not as evident in a low interest rate economy and rising market; say, leveraged loans, housing, and shale gas operations.

How will Fed’s interest rate hike impact China’s economy? Will it further increase downward pressure on China’s economy? How should China respond?
The interest rate hike will increase the value of the dollar against other currencies, including the RMB. This is a challenge for China because discussions of the Chinese currency are highly politicized in the United States, so even a shift in the exchange rate caused by US interest rate policy gets blamed on China. China could hike its own interest rates in response, but that decision has to be in the context of the ripple effects throughout its own economy. Just as rising interest rates in the US will affect some sectors more than others, the same is true in China. So scenario planning around those sectors and potential policy responses is important.

Another important consideration is that normally, a rising dollar would be good for countries that export to the United States. But the trade war has made it very hard to predict anything involving trade trends.

What do you think of Fed’s decision to reduce the times to raise its interest rate next year?
The Fed is walking a tightrope, trying to cool off the markets and head off inflation but not to create a major crash, recession, and deflation. So it’s trying to signal to markets to avoid creating panic. But just because it says now that it won’t raise interest rates as frequently, economic conditions could change, in which case its intentions would change as well.

There has been a debate within the Fed and the markets about how much policy signaling the Fed should do. Over the years it has gone from being extremely mysterious, to giving very clear guidance, to now considering being much more circumspect about what it expects to do in the future. I think the Fed is still trying to find the “sweet spot” between too much and too little information. It’s an ongoing process.

How should investors in the U.S and global stock markets cope with the negative impact of the Fed’s interest rate hike? Are there bubbles in the stock markets of the U.S, especially in technology stocks? And is it possible to get back to bull market?
A bull market like the one we have experienced until recently is not all good. There are many downsides, most of all that when people think they can make easy money in the stock market, they don’t bother investing in less glamorous but ultimately more important businesses that create jobs and goods and services that people need, which in turn create more jobs and goods and services. A bull market leads people to take unwise risks, particularly borrowing “on margin” to buy stocks with money they don’t have; that drives prices higher even faster but makes the crashes even harder, because it forces people to sell when shares fall below the price at which they borrowed to buy it.

Technology stocks definitely have experienced bubbles. For some companies, like Facebook, the bubble is popping not just because of market nervousness, but because of growing public unhappiness with major mistakes by executives.

As concerns about privacy and information manipulation have grown, those companies saw obvious “gray rhino” problems in their relationships with their users. But they ignored them, tried to push them under the rug, and sometimes even outright lied. Now they are paying the price.

Read the article in Chinese HERE.

The Gray Rhino
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