“The Fed is in total denial. It hasn't learned the lessons of what it put the world through a decade ago,” Stephen Roach said, back in January.
“I just go back to 2005 and 2006 where the Fed was so incremental in normalizing rates during a time of enormous froth in property markets, equity markets, credit markets and ultimately that led to huge distortions in the real economy and finally when the bubbles popped, the whole house of cards came down,” he added.
Eleven months later and the Fed is just now getting around to an “incremental” (and if Roach thought past episodes of FOMC policy normalization where “incremental” just wait until he sees the trajectory this time around) hike.
Ahead of tomorrow’s oh so critical Fed decision (which may or may not trigger some kind of dramatic meltdown in EM), Roach is out with some fresh commentary on the Fed, the FOMC’s role in creating asset bubbles, China, and commodities.
“They pushed interest rates down to zero in the depths of the crisis, the crisis ended and they kept the policy rate at an emergency setting,” Roach told Bloomberg TV’s Angie Lau in an interview, bemoaning the fact that the world has been stuck in ZIRP for so long that nearly a third of Wall Street has never seen a rate hike.
The effect of this is and has always been the creation of asset bubbles. As Jeremy Grantham put it earlier this year, “in the Greenspan/ Bernanke/Yellen Era, the Fed historically did not stop its asset price pushing until fully- fledged bubbles had occurred, as they did in U.S. growth stocks in 2000 and in U.S. housing in 2006.”
Now back to Roach. “That [lower for longer rates] is a breeding ground for asset bubbles, credit bubbles, and all-too frequent crises, so the Fed is really a part of the problem of financial instability rather than trying to provide a sense of calm in an otherwise unstable world.”
Right. And you can clearly see this from the following chart via RBS’ Alberto Gallo (note the ever larger swings in the financial cycle):
When it comes to creating speculative excess, it's almost as though the Fed has an unspoken third mandate.
Here’s Roach driving the point home: “While Fed did a great job in reacting to global financial crisis, it played an equal role in setting markets up for the crisis by running uber-accommodative monetary policy.”
He goes on to discuss China which he says “can’t be emphasized enough.”
Beijing’s epochal shift from an investment-led, smokestack economy to a consumption and services-driven model is something many market participants still don’t understand - or at least not fully, he says. “Commodities are, after a super-cycle, obviously going the other way, big time,” Roach said. Some companies “are in denial that China is changing its character, its structure. It’s going to take a while for that to sink in, and until it sinks in, there’s still downward pressure on commodity markets and prices.”
More in the interview below.