Africa is getting closer to Europe by two centimeters a year. Not much, it will be said. Standing on the space station and looking down on this rapprochement would be pretty boring. However, these two centimeters are already sufficient today to cause frequent earthquakes along the Apennine ridge and over the next 250 million years they will rotate Italy towards the north-east, make the Apennines parallel to the Alps and then, after having made the the Adriatic, the Mediterranean and the Po valley will crumble Italy against the Alps, which will once again rise to Himalayan levels and will form the new border between Europe and the Sahara.
Gradatim, ferociter (gradually, relentlessly) is the motto that Jeff Bezos wanted for his real big dream, which is not Amazon but Blue Origin, the project that one day will take millions of human beings into space and extract minerals from asteroids. And Gradatim, ferociter has had caps, coffee mugs, T-shirts and cowboy boots written promoting the vision of him. Describing the US monetary policy normalization program, Yellen said it will be as boring as watching paint dry. Central bankers rarely use metaphors, and Yellen's use of one of two phrases the English language uses to describe slow, harmless change (the other is watching the grass grow) gives us an idea of how much the Fed wants to reassure the markets and politicians on the one hand and how worried it is about the effects that a no longer expansive policy can have on a world full of debts on the other.
More than Yellen, to tell the truth, Jerome Powell clarified the Fed's thinking last week in an important speech, one of those to be put away and consulted periodically (the text is available on the Fed's home page). The course adjustment from expansive to neutral, Powell recalled, began in 2014, when the Fomc decided to end quantitative easing and began preparations for a cycle of rate hikes. This cycle began at the end of 2015 with the first hike in the Fed Funds, continued very slowly in 2016 with another hike, is accelerating in 2017 with three hikes on one side and on the other with the start of the Quantitative tightening (which the Fed will never call that, but in short we understand each other).
Qt will start very slowly, so as to be as little disruptive as possible, but will gradually swell over the course of 2018 until it reaches the respectable size of $50 billion a month. In 2018 there will be another three or four rate hikes, in order to reach the neutral rate of 3 percent (we are talking about a short-term rate) in 2019. But it will not end there because, as Yellen recalled, from 2019 onwards the The neutral rate will in turn start to rise and the Fed, if it wants to keep its monetary policy line neutral, will have to run after it, probably up to 3.5. Meanwhile, the Qt, by placing 50 billion bonds a month on the market until the end of 2020, will raise long end rates, according to Powell's estimates, by 85 basis points. Behind this line is the assumption by the Fed of three hypotheses.
The first is that the economy can still continue to grow at 2 percent a year. The second is that inflation, which has been on a break for three months, will start to rise again. The third is that the Phillips curve is not dead, just numb, and as a result wage inflation will pick up again. A comment on these three assumptions. In the case of growth, it must be borne in mind that central banks, almost by statute, never predict recessions, even though they know full well that they do happen and being one of the most frequent causes of them through rate hikes. Powell's and Yellen's reasoning implies that, should the economy fail to maintain the 2 percent pace, the countdown to the neutral rate would be immediately suspended and an expansive policy would return.
On consumer price inflation, it must be said that central banks, although often wrong too, have the longer view than the markets. Today stock exchanges and bonds have closed the inflation file and are dusting off the disinflation one. Data from the last three months show inflation decelerating and this is enough for the markets to say that we have already seen the peak in this cycle. However, the markets mainly look at year-over-year inflation, ie the inflation of the recent past. The Fed, for its part, is looking ahead and claims that inflation will pick up again.
On the labor market, the Beige Book, drawn up by the regional Feds, is a chorus of complaints about the difficulty for companies to find suitable personnel. This difficulty affects not only high-ranking positions in Silicon Valley, but also mom and dad's little shop looking for a salesperson. Under these circumstances, giving the Phillips curve for dead and excluding that it can suddenly wake up is at the very least imprudent. The small shop cannot use a drone to make deliveries and the day it finds a salesman who does not show up for the job interview in Bermuda shorts and a tank top (a case mentioned in the surveys) he will necessarily have to pay more.
Markets expected a Fed softened by the latest inflation data and instead found a Fed that hasn't changed an iota in its strategy. The disappointment reaction is natural but will soon subside. However, what we need to start meditating seriously on is that in the attitude of central banks there is not only the gradatim that the markets like, but also the ferociter that they like much less and which therefore we tend to remove in analyzes and strategies. Translated into practice, this does not mean that the time has come to sell everything. However, it does mean that, gradatim ma ferociter, in the coming months and quarters the quality of the credits in the portfolio will have to improve or at least reduce the duration of the lower quality ones (it is in the world of credits, even more than in equities, that lurk the areas of greatest overvaluation).
On stocks, in view of greater summer and autumn volatility, it will be necessary to take advantage of the peaks to lighten the sectors that have run the most in the last three months. As for currencies, the take-off of the euro is postponed, not cancelled.
