The Fed faces a dilemma

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Similarities

Since the corona bottom in March, share prices have risen enormously. The results of the presidential election and the arrival of several vaccines brought the rally into an even higher gear. A rally led by shares in the technology sector. After all, the technology funds are seen as the big winners of this crisis. Increasingly, the current rally is being compared to the infamous internet rally of the 1990s. A rally that exploded like a hot air balloon in 2000. Indeed, there are many similarities with the market of 20 years ago. Stock market issues by companies that do not even make a profit but explode on their first day, investors who invest their money in companies (SPACs) that they do not even know where they are going to invest their money in, not to mention sky-high valuations that we have not seen since – indeed – 2000.

One big difference

However, there is one big difference compared to 20 years ago. And that is the monetary policy of the central banks. Twenty years ago, the Federal Reserve, headed by Alan Greenspan, was tightening the reins just a little from the summer of 1999. A year earlier, the central bank had saved the financial world from a complete meltdown as a result of the debacle surrounding the leading hedge fund Long-Term Capital Management and the collapse of the Russian rouble. In order to combat the consequences of these events, Greenspan had set up its renowned Greenspan pit. In other words, the Federal Reserve had cut interest rates. A year later, in the summer of 1999, the Federal Reserve had begun to raise interest rates again step by step. From 4.75 percent to 6.5 percent in August 2000.

Money presses are running at full speed

This time, however, the central bank’s money presses are running at full speed. In the United States, interest rates are now around zero and the central bank buys USD 80 billion worth of government bonds and USD 40 billion worth of mortgage bonds every month. This is a policy that has greatly increased the assets not only of equity investors but also of homeowners. Anyone can think so, but the fact is that Governor Powell of the Federal Reserve not only kept the (world) economy going this spring but also rescued investors. Towards the end of this bizarre corona year, investors around the world bathed in a bath of contentment. But what if Jerome Powell had done nothing? The Governor could at least be nominated for the title of ‘Man of the Year’. Today, by the way, Person of the Year. Maybe that will come of it. Keep an eye on Time magazine. 

No big changes?

Tomorrow the central bankers of the Fed will meet for the last time this year. No substantial policy changes are expected this time. After all, despite the rapidly increasing number of virus infections, the US economy is holding up better than expected. The arrival of the vaccine has also brought some prospects. As a result, the prospects for the coming year have improved considerably. Nevertheless, concerns are increasing for the first time in the coming months. Everywhere, the economy is once again partly or completely locked up. For some time now, applications for unemployment benefits have been on the rise again and so have fears of a new economic slump.

Do something?

The Federal Reserve has already indicated at the last meeting that it is monitoring these developments closely. In this way, it seems to have a few possibilities to do something. It could step up the pace of existing purchases, extend the duration of bonds, or decide to shift the purchasing policy horizon further into the future. Officially, the Fed will maintain its current purchasing policy for a few more months. However, the central bank faces a dilemma. Earlier it indicated that the ball is now in Washington. It is not the central bank, but the US administration that should now come up with a new support package. However, the politicians in Washington do not seem to be getting out of it and time is running out. By acting now, the Fed is allowing the politicians to delay even longer or to abandon the support package altogether. And that is not what the Fed wants. By doing nothing, the Fed is keeping the pressure on for a while. Perhaps until the next meeting.

To act or not to act?

It is now up to the Fed. House prices in the United States have risen again by 7% last year. Should there be any more support for homeowners? The stock markets are at record levels. The same applies here. There is nothing more stimulating for investors than knowing that there is a central bank with deep pockets, ready to take over assets from you at any price. But the economy – read the man in the street – is in a much worse shape and the politicians in Washington are not getting away with it. What is Powell going to do? For investors, he is already the Person of the Year. Will he be the Person of the Year for the US economy as well?

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