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Star gazing

Banking Essentials Newsletter - November Edition

University Essentials | COVID-19 Economic Outlook in Banking: Rates and Long-Term Expectations: Q&A with the Experts

Estimating Credit Losses Under COVID-19 and the Post-Crisis Recovery

StreetTalk – Episode 70: Banks' Liquidity Conundrum Could Fuel M&A Activity


Star gazing

Nancy Bush is a veteran bank analyst. The following does not constitute investment advice, and the views and opinions expressed in this piece are those of the author and do not necessarily represent the views of S&P Global Market Intelligence.

There are times in these chaotic and nerve-jangling past weeks when I have felt like a member of the alien family that was plunked down upon Earth in that old (and much under-appreciated) sitcom "3rd Rock From the Sun." For those who may not have seen this show — and are in need of a laugh in these humorless days — I strongly suggest that you do some serious binge-watching. I can almost guarantee that any rational American of a certain age (like mine) will strongly identify with this cast of strange characters who have landed in an unfamiliar environment and are then expected to act like a normal American family. (Spoiler alert: they don't.)

I don't know if it has been the after-effects of the Financial Crisis or the presidency of Donald Trump — and I would strongly contend that the former has led to the latter — but I increasingly feel that the moorings of the financial landscape are shifting under my feet. While it is a given at this point that the American banking system is strong and well-capitalized — and grudgingly conceded by the industry that the Dodd-Frank legislation has been instrumental in getting us to this place — the underpinnings of American finance as we go into the future seem to me to be rather confused.

I welcomed the ascent of Jerome Powell to the position of Federal Reserve Chairman, for several reasons. First and foremost, I had grown weary of the dominance of the "academic cadre" at the Fed, where neither Ben Bernanke nor his successor Janet Yellen had ever run money or run businesses, and I felt that it was time for the Fed to get a jolt of real world expertise. While no one (OK, maybe a few) can fault either Bernanke or Yellen on their stewardship of the economy in the aftermath of the meltdown and during the years of recovery, it was simply time for "normalcy" to become the watchword and for the Fed to begin to pursue a path back toward a lesser role in the national psyche.

And Powell has (mostly) gone down that road. I'm not the only one who has been surprised and pleased by the degree to which he has chosen to use plain language and straight talk to outline the route the Fed is going to take, dropping the parsing and economic arcana that were the trademarks of his predecessors. (Since Chairman Alan Greenspan mostly chose to say nothing, it really didn't matter.) Indeed, Powell's first public commentary as chairman was so straightforward that he took the markets by surprise, as he said what he meant — that it was time to normalize Fed policy and that part of that process would be a consistent and measured program of raising rates.

He has stuck to that script in the face of a meltdown in emerging markets, a crisis of confidence in Turkey, the escalating threat of a tariff war between the U.S. and China, haranguing from Donald Trump as rates have risen (what developer doesn't want low rates?) and daily second-guessing from market pundits about whether the Fed is pushing rates too far and too fast. So perhaps it was inevitable that Powell would take the opportunity of the Fed's annual meeting in Jackson Hole to try to clarify his latest thinking on inflation and the path of rates.

Maybe that was not a good idea, and I hope that we do not go back to the days of the "dot plots" and "data dependency," where the data targets change with each Fed meeting and the Fed governors and regional presidents engage in a public airing of their differences and debates that just confuse everybody. Perhaps I am being overly sensitive to this issue, but it seemed that there was some backsliding on Fed consensus at Jackson Hole — perhaps exacerbated by the presence of so many reporters with a need to generate some buzz on what are really deadly dull topics.

In any case, Powell had some interesting commentary that certainly drew the attention of reporters and us common folk alike. He likened the process of finding the desired level of interest rates to navigating according to the stars while at sea — only the stars he was referencing were the "u-star" (the natural rate of unemployment) and the "r-star" (the natural rate of interest) and how the Fed had to be aware of the interplay between these two economic conditions as it plotted (that word again) the way forward.

Apparently this will be no mean feat: "The risks from misperceiving the stars also now play a prominent role in the FOMC's deliberations... One general finding is that no single, simple approach to monetary policy is likely to be appropriate across a broad range of plausible scenarios," Powell said.

I would strongly recommend that everyone give some time to the Chairman's speech on the Fed website, because it is chock-full of recent economic history and the rationale behind some of the Fed's past actions. But its conclusion is clear — buckle up, because it's going to be a bumpy ride. Apparently gone are the days of the accomodative Fed, bending to the will of the markets and telegraphing well in advance what the next move may be. Those moves may be abrupt and they may be unexpected, because it seems highly likely that the economic stars are going to be way less predictable in their location and in their courses — and in their magnitude — than the astronomical stars may be.

While Powell may have changed the tenor of the dialogue at the Fed, he is guilty — as were his predecessors — of one important omission, and that is a dialogue with the people in America who save money and have seen little reward for it over the past decade. Bernanke and Yellen skirted the issue entirely when asked about it and I do not want to see Powell make that same mistake, as I believe that the Wall Street-Main Street divide was exacerbated by a lack of clear declaration on the part of the Fed’s leaders. If those in this country who eschew debt and save instead are unlikely to soon see a decent return on their savings, it is up to the Fed Chairman to explain why.

I hope that we all will grow more comfortable with this new reality, but it's going to take a while. I have been rethinking my own portfolio — perhaps it is finally time to take some risk off the table — and a number of bankers with whom I have spoken in recent days are beginning to feel the same way. The strange shape of the yield curve and the growing likelihood of an inversion in the next few quarters has clearly got some folks in the industry spooked, and I spoke with few who were willing to say "but this time is different." It may be in the stars for Powell, but it is not in the stars for me, and I increasingly feel that I have seen this movie before.

One final mention of "3rd Rock From the Sun." As watchers of the show know, there was a shadowy character — apparently the ruler of the planet from which the Solomon family had descended — who was known only as the Big Giant Head. As the series was winding down, the Big Giant Head came down to Earth to visit the Solomons in the person of — who else? — William Shatner, and was revealed to be a petulant man-child who quickly discovered alcohol and women and went on to wreak chaos everywhere he went. I can only conclude that life sometimes eerily mirrors art — and sometimes especially mirrors sitcoms.