Asset prices when the Fed starts to care about inequality

Markets were pretty strong this week and of course the market commentary in the press was full of the usual content surrounding trade and Brexit.

The big news on both was: Trump signed the Hong Kong Bill and the most granular poll on the UK Election to be conducted to date suggested the Conservatives would win a majority of 68 seats, including many in Labour’s traditional heartland and only lose two seats to the SNP in Scotland.

Those two important topics will be discussed in more detail next week but this week a break is warranted from the analysis of the twists and turns of the US-China trade dispute and Brexit. The focus of this note is a topic which is likely to gain more traction in the press over the coming years.

The effects of Populism

As readers are doubtlessly aware, one of the most important topics driving financial commentators’ thinking on the current political discourse is the concept of populism and what populism means for the political composition of future governments. However, it is also vital to think about what the emergence of populism will do to asset prices. The increase in populism can probably be attributed to the increase in inequality within countries which has taken place over the last 20 years. Now this may lead to more left leaning action from governments but what if this also has an influence on monetary policy?

The cost of persistently excessive unemployment

In February of this year the highly respected economist Abigail Wozniak was appointed to lead the Minneapolis Fed’s Opportunity and inclusive Growth Institute. This appointment indicates that the Federal Reserve, the US central bank, has come around to the opinion that its policies do have a role in earnings distribution outcomes. As one of the most respected Federal Reserve analysts, Tim Duy, notes: persistently excessive unemployment has its costs. Not only does the period of low unemployment not extend long enough to spread its benefits to the most challenged sections of the labour market but the period of low unemployment is also not long enough to tip the scales toward employees when it comes to wage bargaining.

Where does this leave asset prices? The implication of a broad acceptance of the idea that the Fed may have contributed to inequality in the past is that the Fed is likely to be more cautious when raising interest rates and responding to economic weakness much more quickly. So, if the industrial production cycle does turn up then the Fed would be less likely to rush to raise interest rates and this is why remaining market weight in equities makes sense, despite the length of the current economic cycle.

© 2019 GWM