Monday 22 January 2018

Fed reports hint at major shake-up

James Saft

The bad news is we are going to have another crisis. The good news is that, by then, promoted messages on Twitter will make it easy to find bankruptcy attorneys.

Yes, this was the week that Twitter went public at a stratospheric valuation and the Federal Reserve set the stage for yet more aggressive monetary policy. Those events are linked and though it may take a while, both will bear some bitter fruit.

Twitter, a great but overvalued company, is likely to ultimately disappoint investors. That may well happen when an overly confident and aggressive Fed finally gets its comeuppance. Or rather, gets the latest in a series of comeuppances.

First, let's look at Twitter, which opened at $45.10 (€33.58) per share, 73pc above its IPO price. That put its market cap at about $32bn, or 53 times sales, making it the most expensive single technology stock on a price-to-sales basis.

I can't shake the feeling that technology shares are suffering from, for want of a better phrase, irrational exuberance.

You never get a bubble without a good story, and rarely without some earth-shaking change in technology, but it also helps if you have one more thing: loose monetary policy.

That the US has, in abundance. Judging from the noises coming out of the Fed, we may well soon be about to make a great leap forward in radical monetary policy.

Two papers by Fed economists were released in conjunction with a conference this week. The one that got the most attention, by William B English, J David Lopez-Salido and Robert J Tetlow, argued that the Fed can cause unemployment to drop more quickly by pledging to hold interest rates pinned to zero for longer than they do now. Called forward guidance, this is a policy under which the Fed simply tells the market what it will do and waits for the market to reprice credit in response.

The paper argues that the Fed could use a lower unemployment threshold for rate rises than its current 6.5pc, perhaps 5.5pc.

But will investors genuinely believe a forward commitment by the Fed, or any other central bank, for that matter?

The second paper, by David Reifschneider, William W Wascher and David Wilcox, posits that following a crisis, a central bank might do less damage to the economy by fomenting a second crisis by holding rates low than by raising them to avoid a bubble and bust.

This paper centres on the concept of 'optimal control,' essentially specifying what you will tolerate as a central banker in terms of inflation, unemployment and other variables, and then making assumptions about how policy and the economy will interact.

This is a technique that has been approvingly cited by Fed chief-to-be Janet Yellen.

Again, this only works if, first, people believe the Fed will do what it says it will, and, second, that the Fed is actually good at forecasting and understands how the economy works.

Neither point is believable.

It is impossible to know if this is simply musing, or if this represents an evolution of thought at the Fed.

What seems clear, and you only need look at Twitter to see, is that the markets believe that monetary policy will be good for risk assets.

Two financial busts in 13 years apparently aren't enough. (Reuters)

Irish Independent

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