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The Yellen and Carney Show

I’m angry with Fed chair Janet Yellen and Bank of England Governor Mark Carney. Why did they have to be so eager to raise interest rates, talking them up in the way they did? Yellen’s trigger happiness has caused the Dollar to rise, oil prices to fall, China to devalue its currency, other emerging markets to devalue theirs, inflation pressures (to the extent there were any) to subside and, guess what, the case for raising rates to be booted into touch.

Actually, it’s worse than that. By calling for rates to be raised too soon, Yellen has lost a lot of credibility. Central banks have been virtually single-handedly propping up the global financial system, so their credibility is paramount. I remember five years ago wondering which would come first; a global economy returning to “normal” or loss of faith in central banks. The last few days and weeks have seen me shifting my views firmly in favour of the latter.

My main bone of contention is that the end of QE in both the UK and the US constituted an effective tightening of monetary policy. As I noted in my last investment letter, it is estimated that the tapering of asset purchases in the US was the equivalent of an interest rate rise of 4 percentage points. This is the same as the entire tightening cycle of 2003 to 2006, which saw the Fed Funds rate go from 1% to 5%, and which arguably triggered the financial crisis. Why oh why couldn’t Yellen or Carney communicate the message that having had a substantial effective tightening, they would leave interest rates where they were for at least 2 years in order to gauge its effects? It’s not as if we were coming out of a normal recession in which inflation pressures were going to rebound quickly. Far from it. Inflation still needs propping up not suppressing.

I’m not an economist – thankfully! – but it seems to me that the world is prone to deflation not inflation. We humans seem to be able to find cheaper ways each year of making something or providing a service. Furthermore, while credit creation is inflationary, the reverse is deflationary. Throw in other sources of deflation like the internet or China and you have a world in need of central bankers not competing to be the first out of the blocks.

Fortunately, our Funds are neutrally positioned at the moment with respect to equities. This means our income fund has 40% in equities and growth fund and investment trust have 60%. While in these sorts of markets one always wishes one was more defensively positioned, I think neutral was right. While equity market valuations weren’t cheap, nor were they expensive. Furthermore, despite what Carney and Yellen say they would like to do, the reality is that monetary policy is likely to remain loose and thus supportive – at some point – of markets.

As for China, its one dimensional economy that relies on building more and more “stuff” has always been vulnerable to a nasty slowdown. China needs to break away from a model that has seen its consumption of cement and steel break all global records towards one that is more balanced. The good news is that in a command economy, the state is in a position to direct such a shift.

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