The market is ‘finally getting the joke’

This is the title of a note written a short while ago by Scott Minerd, a manager at an investment firm. He wrote the note to investors who still do not believe the United States Federal Reserve will raise rates, despite all the signals from the FED itself that it will.

Since the end of January, market players have been edgy. At the beginning of January, inflation was high and followed an episode of short-lived but strong volatility in the markets. Afterwards, the markets experienced somewhat of a recovery, but everything is still “on a knife edge.” Morgan Stanley, one of the large investment banks, described the volatility as “just the appetizer, not the main course.” This is obvious: Fund managers, who dreamt about “low volatility and high return” and became used to make easy gains, now feel uneasy.

“Desperate central bankers” made those easy gains possible. They were desperate because, as always, it was them who had to put out the fire. Central banks tried to put out the fire by flooding markets with abundant and cheap money, but at the same time this practice had a “one-sided” effect: Gains made by financial markets and risk appetite exploded. Politicians did everything possible to “buy some more time” while passing the buck to central bankers.

The end of the movie

“Do you know how precious 24 hours in politics is? Please save the day.” I heard this sentence back in 1994 from the then prime minister through the speaker phone at the central bank’s fund management office.

“The end of the game” is approaching, as minutes released on Feb. 21 from the latest FED meeting had clearly signaled.

In December 2017, when the FED hiked its rates, it also released forecasts by FED chair and Federal Open Market Committee (FOMC) members that had predicted three rate hikes in 2018.

The minutes from the January meeting showed that FED officials agreed that economic outlook is now stronger than it was in December last year, which will necessitate more gradual rate increases. FED officials also agreed to add the wording “further gradual increases” into the minutes. This, in effect, means at least four rate hikes starting from March this year.

Analysts, who were asking a month ago whether the “FED would opt to raise hikes two or times” are now asking whether there will be “four or five” hikes.

Three Fed rate hikes not enough

Following the release of the FED minutes, David Mericle, an economist at Goldman Sachs, argued in a podcast that he maintained his forecast of four hikes, but he talked about the possibility of the FED adding one more hike and delivering a total of five hikes this year.

Apparently, U.S. President Donald Trump’s tax and spending policies and protectionist measures will overheat the economy and push inflation higher.

The FED is unwinding its balance sheet by $20 billion a month and this amount will increase to $50 billion in October. As the FED is reducing the holdings of U.S. Treasury bonds, the Treasury will have to borrow more because of the budget deficit and tax revenue losses. The long-term interest rates will continue to rise and short-term rates will also gradually increase.

While all of that happened the other night, we read in the morning paper that the Turkish Prime Minister Binali Yıldırım said “there were negotiations to lower interest rates and inflation” and that the outcome of those negotiations would be unveiled in a meeting scheduled for March.

At a meeting of Turkey’s Foreign Economic Relations Board (DEİK) on Feb. 21, Yıldırım said, “All indicators are good but why are interest rates not at the desired levels? Why was inflation above expectations at the end the year? We are looking for answers to these questions. Responsibility does not lie solely with us. Everyone, doing business in Turkey, is responsible. This is a shared responsibility. We have to carry out this struggle all together with a sense of national mobilization.”

This statement, which translates as “we could not bring inflation under control but you should bring interest rates under control,” might be followed with another statement suggesting that “the FED is responsible for both inflation and interest rates.”

As global conditions change rapidly, voter-oriented statements from politicians only increase financial vulnerabilities. I wonder when we will “get the joke.”