The U.S. Federal Reserve is using forward guidance and verbal interventions to nudge markets into doing its bidding, according to Credit Agricole’s Head of G-10 FX Research, Valentin Marinov.
Speaking to CNBC’s “Squawk Box Europe,” Marinov said that by using the combination of forward guidance and its outlook for rates, the Fed is “hoping that the markets will do their job for them.”
The Fed has hinted at rate cuts in 2019, but Marinov suggested markets had “gotten a bit ahead of themselves” by pricing in “imminent, aggressive rate cuts.”
“U.S. financial conditions have eased dramatically, and it also reduces the pressure on the Fed to act,” Marinov said.
“If anything, the best that the Fed can hope to do now is to try to avoid any escalation in the market tensions, and any unwarranted tightening in the market financial conditions.”
Marinov suggested that the central bank has two tools at its disposal. One is cutting interest rates, but the other is “effectively promising that they will deliver the goods, hoping the markets will respond to that and in the process do their job.”
Although he suggested that at some point markets will “call their bluff,” Marinov did not believe that this would not be imminent, describing rate cuts as a “precious commodity.”
“If the real issue is a slowing U.S. economy and your job as a central bank is to smooth the ride to engineer a softer landing, you should be quite cautious implementing those rate cuts,” Marinov added.
Jim Reid, Global Head of Thematic Research at Deutsche Bank, agreed that Powell had to play the markets at this stage. He told CNBC that although markets had “raced ahead” and priced in over 100 basis points of cuts in the next 12 months, Powell would not be convinced of that necessity.
“But unless he gives the market some impression that he is willing to be flexible and keep optionality, then the market will probably aggressively sell-off, which will make his job more difficult, so he has to play along with the market a little bit here,” Reid said.
On Tuesday, Powell tempered hopes of an imminent rate cut slightly, stressing the importance of the central bank not reacting to individual data points or short-term political pressures.
“One of the biggest problems the Fed has is that we have developed a financial system that is so big that it has the power to dictate monetary policy, because if the market says something that they think is going to happen and then the Fed, or another central bank, disagrees, you could get some pretty severe sell-off,” said Reid.
“Then you get financial conditions tightening, and it’s a vicious circle, so they are a little bit beholden to the markets.”