Is the Fed breeding complacency?


Simon Stevenson

Simon Stevenson

Deputy Head of Multi-Asset

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."

James Carville, Adviser to President Bill Clinton.


US monetary policy is currently at emergency settings: the official cash rate is effectively at zero and the US Federal Reserve (Fed) is buying bonds, pumping money into the system.  However, the emergency has passed.  The banking system has been recapitalised[1], growth has been positive for an extended period of time, and the unemployment rate has fallen sharply from the peak of 10 per cent to 6.1 per cent. All the while markets have responded benignly to this dichotomy between policy and economic fundamentals.

This article explores the apparent complacency of market participants. Markets continue to respond in line with rhetoric of the Fed, which argues that because of excess economic slack[2], they can aggressively stimulate growth without creating an inflation problem. However, less traditional measures of slack are not as benign, suggesting that the Fed and markets may be underestimating economic risk. The last time this was the case, the late 2000s; it led to the severe disruptions of the GFC.

[1] The leverage ratio for the US banking system is the healthiest it’s been since 1984 - from which FDIC data is available.

[2] The Fed believes that there is “significantly more people willing and capable of filling a job than there are jobs for them to fill” (Yellen, 2014).


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