Fed Risks Stoking Financial Bubble in Drive to Lift Inflation
The Federal Reserve risks stoking the same sort of asset bubbles that Chairman Jerome Powell has linked to the last two recessions with its new-found eagerness to fan inflation. The Fed’s surprise pivot away from any interest rate increases this year has boosted prices of stocks, high yield bonds and other risky assets in spite of nagging investor concerns about slowing global economic growth. Financial conditions, at least as measured by the Chicago Fed, are at their easiest since 1994. And they could well get looser. “If by late spring it feels like growth is picking up and the Fed is on hold, the markets are going to say Goldilocks is back and it’s risk on,’’ said former Fed official Nathan Sheets, who is now chief economist for PGIM Fixed Income. That would put policy makers in a pickle. In unveiling the Fed’s U-turn last month, Powell highlighted the central bank’s determination to promote price pressures by declaring that low inflation was “one of the major challenges of our time.’’ And he left open the possibility that the Fed’s next rate move might be a cut after four increases last year. But a drive to boost inflation through low interest rates could end up threatening financial stability by encouraging supercharged risk-taking, according to Allianz SE chief economic adviser Mohamed El-Erian. And it’s just such “destabilizing excesses” that Powell has pinpointed as leading to the last two economic downturns. First it was the dot-com stock market boom of the late 1990s that crash landed and led to the 2001 recession. Then it was the housing boom and bust of the 2000s that preceded the biggest economic contraction since the Great Depression. The quandary for the Fed is that easy monetary policy seems more effective in spurring asset values than it does in boosting prices of goods and services.
Euro Area Gets Some Good News to Offset Manufacturing Gloom
The euro-area economy got a modest lift on Wednesday as activity in services came in stronger than anticipated at the end of the first quarter. Purchasing managers’ indexes for the region’s four largest economies provided some much-needed good news that helped to push the euro higher. Italy and Spain beat economists’ forecasts, and March readings for Germany and France were revised up compared with flash estimates. Retail sales for February rose 0.4 percent, topping the median expectation. A slump in global manufacturing has dealt a severe blow to the euro area’s export-heavy economy, with Germany in the midst of an industrial recession and France dealing with additional disruptions from anti-government protests. The weakness could yet spread from factories to services, further undermining confidence and broader prospects for the region. The headline services gauge for the euro area jumped to 53.3, the highest since November. That lifted a composite measure for manufacturing and services to 51.6 — better than the flash reading but still lower than the previous month. The figures from Europe followed bright news in Asia, where China’s services PMI jumped to the highest since June. Stocks rose, also boosted by optimism that the U.S. and China will reach a trade deal as talks resume in Washington. The euro gained 0.3 percent to $1.1239 as of 10:38 a.m. Frankfurt time, and Italian bonds advanced. “The service sector has managed to sustain a relatively resilient rate of growth but has also lost momentum in recent months,” said Chris Williamson, an economist at IHS Markit. “Unless manufacturing pulls out of its downturn, the overall pace of economic growth will likely weaken in the second quarter.”
China-U.S. Trade Talks Enter Crunch Period as Liu Arrives in DC
Chinese Vice Premier Liu He will resume negotiations with his U.S. counterparts in Washington on Wednesday as both governments push for an agreement to end their protracted trade dispute. The latest round of talks follow discussions last week in Beijing, where Liu met with U.S. Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer. Outstanding issues include protection for intellectual property and how to enforce any broader trade agreement. China touted “new progress” after last week’s talks and both sides have been working line-by-line through the text of an agreement that can be put before Trump and Xi, according to people familiar with the matter. China has already announced various concessions and pledged to open up industries in steps. Asian stocks bounced with U.S. and European equity futures Wednesday on expectations that a deal could soon materialize. Treasury yields rose. Any hint that the talks have run into deadlock will unnerve investors and trigger fresh concerns for the world economy, which has already been rattled by tit-for-tat tariffs that the U.S. and China have imposed on each other’s goods. Both countries have yet to agree on what happens to existing U.S. duties on Chinese goods and the terms of an enforcement mechanism to ensure China keeps to the trade deal, the Financial Times reported, citing people briefed on the talks. Other than that, U.S. and China officials have resolved most of the issues surrounding the deal, the FT reported. Negotiations so far have focused mainly on what China will do to reduce its goods trade surplus with the U.S., which reached a record $419.2 billion last year. Beijing has made some big offers in this area, such as a pledge to reduce the deficit to zero by 2024 — close to the end of a potential Trump second term.
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