HAMISH MCRAE: America is leading the world back to common sense

If you wanted a reminder of where the power lies in global finance, this weekend is as good as any. Is in America. This is not simply because the US is the world’s largest economy, or because US stock markets account for more than half of the world total.

It’s also because the rest of the world looks to American leadership on financial matters. In particular, what the US Federal Reserve does shapes the policies of every other central bank in the world. And that’s why global markets are paying close attention to what Jay Powell, chairman of the US Federal Reserve, said at the annual meeting of central bankers in the resort town of Jackson Hole in Wyoming on Friday.

In a normal year, the Jackson Hole meeting is a quiet academic affair. Since 1982, central bankers, economists, academics, US officials, etc., have gathered there to talk about the long-term forces shaping the world economy and its money markets. This year things are not calm at all. Everyone is afraid, and we all know why. The central task of central banking is to maintain financial stability. Back in the 1980s, the great threat was double-digit inflation, a beast that was defeated by the harsh policy of double-digit interest rates.

Even a year ago they weren’t really worried. The Fed thought the slight uptick in inflation was ‘temporary’. There was no need to raise interest rates and the cash flowing into the markets through quantitative easing would slowly ‘draw’. Markets calmed and the stock market boom continued in the United States, lifting stock prices everywhere, until the end of the year.

The Fed now knows that its complacency a year ago was absurdly misguided. All the progress of 40 years of fighting inflation is at risk. But just as markets took solace in the calm message a year ago, before realizing that they had been duped when the Fed started raising interest rates faster than expected, this weekend they are once again looking for guidance. . So what is the message now?

Well, Jay Powell spoke tough. I think he had to do it. Going back to the Fed’s 2 percent inflation target was his “general approach at the moment.” “Restoring price stability will likely require maintaining a restrictive policy stance for some time,” he said. ‘The historical record strongly cautions against premature policy easing.’

But what does this really mean, not just for the US but for the rest of us? If the Fed’s target interest rate peaks between 3.5% and 4%, does that mean the Bank of England’s base rate will go up there too?

Will ‘a tight policy for some time’ mean there will be another leg down for US equity prices, after the partial recovery since mid-June? And will UK stocks, which are cheaper than US stocks relative to company earnings, be able to withstand a downturn in US markets if that happens?

It’s always worth waiting a few days for things to settle down after an important political speech like this, because first reactions are often wrong. We have this holiday weekend to reflect, and we are one week away from the US end-of-summer holiday, Labor Day. But for what it’s worth here are my top five takeaways. First, Jay Powell means what he says. The Fed will lean on inflation until it comes down towards the 2 percent target on a sustainable basis.

Two, that means the Bank of England will have to do the same. Our own prospects are confused by the new government and the large increase in loans needed to offset rising energy costs. But it will be difficult to maintain confidence in the pound through the fall and we don’t want the pound to drift. Therefore, the pressure will be on the Bank to keep raising rates until there is a turning point for inflation.

Three, while I don’t know where that rate spike will be, I’m still not sure a recession is inevitable. Winter will be messy, but the government’s big push to offset power bills should keep the economy from contracting much, maybe not at all.

However, number four, the rise in UK house prices will be limited by rising mortgages. It’s probably not a crash, just a duller market. And finally, what about share prices? The immediate reaction was that US stocks headed sharply lower, although there was less movement in London. Let’s wait a few days.

My instinct is that we are back in markets where value matters. Solid companies with decent profits will do well, but the foam will go away. If so, that will be good news. America is leading the world back to common sense. It’s about time, but welcome anyway.