The global economy is on the brink: Europe is headed for recession, Japan as well and China’s growth rate is the slowest in almost thirty years. Only the economy in the United States seems to hold up. But for how long?
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“We live in a global world and if Japan and Europe are struggling and the world has a problem it’s going to come to the US eventually”, says Jim Bianco.
According to the internationally renowned macro strategist, the biggest threat to the US economy is the inverted yield curve. “This is the market’s way of saying the Federal Funds Rate is too high and must come down”, Mr. Bianco is convinced.
Against this backdrop, the founder and President of Chicago based Bianco Research argues that the Federal Reserve should cut its target rate by 50 basis points at the next FOMC meeting. He also cautious against introducing negative interest rates in the United States during the next recession because in his view that would cripple the global financial system.
In this at-length interview with The Market, the profound financial market observer explains where he spots opportunities for investors in today’s challenging economic environment.
Mr. Bianco, the summer is basically over and we are heading into the final stretch of the year. What’s ahead for the financial markets in the coming months?
There are two issues at play: First, the trade and currency wars where the situation reminds me somewhat of “This Is Spinal Tap”. It’s a cult satire movie from the eighties about a rock band and they coined the phrase “up to eleven” because that’s how high their amplifier went. So the expression “turning it up to eleven” refers to the act of taking something to an extreme. I’m saying this because I think Trump is “going to eleven” on trade: He’s going to turn it up so high that there is going to have to be a deal. That’s the way he wants to do this. He will just make it intolerable so everybody has to sit down and cut a deal.
What’s the other issue?
The inverted yield curve. The three-month/ten-year curve has been inverted since May and this is the market’s way of saying the Federal Funds Rate is too high and must come down. It is interesting how hard everyone is standing on their head to dismiss the yield curve and tell me why it’s different this time. This is not surprising, as it tends to happen every time the curve inverts until the recession hits. It might be different this time, but I still think that the yield curve is telling us that the Federal Reserve has to cut rates and it has to cut them aggressively.
Why is the inverted yield curve such a problem?
An inverted curve damages the economy. Accumulate enough damage and the economy sinks into recession. So, the curve does not predict a recession, it causes it. What is not known is how much damage the economy can withstand. Currently, the three-month/ten-year curve is at -49 basis points. It hit -52 Sunday night and it’s getting close to the 2007 extreme of -60, which is the most inverted reading of the last two decades.
You were interviewed by the White House in May for one of the open positions on the Board of Fed Governors. What should the Fed do at the next FOMC meeting on September 18?
The late economist Rudi Dornbusch coined the phrase that the Fed murders the economy by holding policy too tight for too long. Well, take careful note because that seems to be what the Fed might be doing yet again. The market is screaming to cut rates aggressively and the Fed is fighting it. So the question is how much it takes to un-invert the yield curve. At -49 basis points, that means a 25 basis point rate cut at the FOMC meeting next month is not going to un-invert the curve. You are going to need to cut 50 basis points or something along those lines.
At 2 to 2.25%, the Federal Funds Target Rate is already quite low. Shouldn’t the Fed be more careful than usual with its ammunition?
The “running out of bullets” argument is dangerous: either Fed cuts work or they do not. If cutting rates do not stimulate now, they will definitely not work if you save them until things get worse. Holding them back does nothing. So go hard now, cut hard now. If it works, great. If it does not work, saving the bullets for a rainy day would not have made a difference anyhow.
Then again, at the Jackson Hole conference last week Fed Chair Powell reinforced his view that the US economy is in good shape. Where do you see trouble brewing?
You don’t see it in the economic data but you will find it when you look at interest rates in the developed world. Today, the highest interest rates in the developed world are the 30-year Italy government bond and the Fed Funds Rate at around 2.1%. The Fed Fund Rates has never been that big of an outlier before. So the market is saying: We live in a global world, relative interest rates matter and the Fed Funds Rate is out of line with everything else.
Why do relative interest rates matter?
There was a paper delivered on Saturday in Jackson Hole about the effects that globalization has on monetary policy. It pretty much said the same thing: The reality is that we live in a global world. So you have Draghi at the ECB being at -40 basis points and Kuroda at the Bank of Japan being at -10 basis points. They’re dragging their rates to negative which is forcing the rates in the US down as well. The global economy is going to be perceived as weak and on top of that, you have the whole trade situation. That’s why the bond market is going to continue to send messages that there are problems and I think the stock market is going to continue to churn sideways to lower until there is some kind of resolution.
How serious is this threat to the global recession?All those low global rates are signaling a big problem in the world. I think Europe is in a recession. Italy has negative GDP and Germany had three of the last four quarters either zero or negative GDP. Industrial production numbers out of Germany are terrible, and Japan is very close to being in recession, too. At the same time, economic data in China is at thirty years lows. That’s what’s holding interest rates in Europe down all the way to negative and is forcing the rates in the US down as well. We live in a global world and if Japan and Europe are struggling and the world has a problem it’s going to come to the US eventually, too. That’s why the market is telling us the Fed has to cut rates.
So why isn’t there a greater sense of urgency at the Fed? At the last FOMC meeting, Powell characterized the first rate since 2008 as a “mid-cycle adjustment,” not “the beginning of a lengthy cutting cycle.”
The problem is that nobody knows what mid-cycle adjustment means. As we speak, the market is pricing in four more rate cuts in the next year. That means a total of five rate cuts, including the July 31 rate cut. So the market is pricing in something that the consensus of economists is nowhere near. If you look at a recent Bloomberg survey, only seven of sixty economists had the Fed cutting rates five times. The other 53 had the Fed cutting less than five times. What’s unusual about this cycle is that the market is an outlier right now. Again: it comes back to the fact, that consensus economists are looking at US domestic economic data and they don’t see trouble whereas the market is looking at global data and it sees trouble.
Read the full article here by Christoph Gisiger, The Market NZZ
