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LGT Investorama: Fed lured out of its reserve?

November 21, 2019

Do you remember the time when monetary policy was basically considered an extremely boring discipline that did not interest ordinary people outside a small circle of nerdy economists in universities and research departments of financial institutions? Monetary policy changes could hardly provoke more than a side note in the business section; they certainly did not generate any headlines on the front page of daily newspapers. Tempi passati – but what has “monetary progress” brought us?

There used to be the “old school” of an independent, stability-oriented monetary policy, in which above all adherence to principles and (boring) regulatory rules were the main focus. The calculations of the political decision-makers were based exclusively on flawless economic statistics and inflation indicators – with not even a sideways glance at the stock markets...

Around 20 years ago, Alan Greenspan, the legendary former chairman of the Federal Reserve, was the first to voluntarily or involuntarily create a cult around himself with his sibylline rhetoric and sign language – including a host of analysts who literally hung on his every word and tried day in, day out to interpret his gestures. “If I've made myself too clear, you must have misunderstood me," was one of his favorite expressions, and it became quickly known as “Fedspeak.” 

About a dozen years later, on July 26, 2012, Mario Draghi, the shrewd former president of the European Central Bank, managed to top the unforgettable “Easy Al.” With his three magic words “whatever it takes,” he managed to do what neither hundreds of billions of euros in aid nor countless crisis summits had been able to do before: a sudden calming of the financial markets in the midst of the European debt crisis. Unfortunately, this date also marks the end of that legend of apolitical technocrats of the “old school” pursuing a discreet monetary policy. Anyone who still believes or claims that central banks should actually be independent of the rest of politics is no longer taken seriously, but laughed at as out of touch with reality. 

The list of developments that confirm this irreversible trend on both sides of the Atlantic right up to the present day are almost endless. These developments include, for example, Jerome Powell’s most recent turnaround or paradigm shift, which is difficult to comprehend from an economic point of view. Since this change of direction, he can no longer get rid of the suspicion that he is dancing to Trump’s Twitter pipe, or at least letting it lure him out of his reserve. And while in some places politics is exerting more and more influence on central banks, in other places politicians are being appointed to head the banks: A point in case is the election of Christine Lagarde as president of the ECB! 

Complaining about the lost independence of central banks has become popular. In Switzerland, it has come predominantly from the ostensibly (but not necessarily!) superior point of view of a publication such as the Neue Zürcher Zeitung. From a Swiss perspective in particular, this is out of place: We are reluctant to remember Switzerland's original sin in September 2011, when Philipp Hildebrand, then Chairman of the Governing Board of the Swiss National Bank, proclaimed with extreme determination and monetary omnipotence that he would no longer tolerate a euro-franc exchange rate of less than 1.20 with immediate effect. This game of chance, which was staged under political pressure and in the worst case could have led to disaster, lasted 1,227 days, until the SNB capitulated in January 2015. 

Conclusion: In contrast to the central bank governors mentioned above, investors should not let themselves be lured out of their reserve, and under no circumstances should they throw their proven strategy overboard or overestimate their risk capacity. This danger is imminent due to the well-known investor preference for interest rate cuts – on the one hand, because they are expected to stimulate the economy, and on the other, because low interest rates make risk investments such as equities more attractive compared to bonds.

Caution is called for, as the futures markets may currently be overestimating the cycle of interest rate cuts, which could lead to disappointment. Further uncertainty arises from the fact that interest rate cuts are not an absolute panacea for averting recessions. Over the past five decades, this recipe has been unsuccessful in almost half of all cases – resulting in average losses of approximately 25% in stock indices. If a recession was actually prevented, the stock markets managed once again to make further strong gains, albeit only after an extremely volatile transition phase. In view of this particularly high scenario divergence and a risk-reward ratio that has become less favorable after more than ten years of a bull market, it is advisable not to enter into excessively large tactical bets at present. In contrast, it is a good time to add some gold to a portfolio as a reserve for all scenarios, even though some know-it-alls might shake their heads in disapproval.


Dr Alex Durrer

Chief Economist

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