Submitted by Taps Coogan on the 27th of November 2019 to The Sounding Line.

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Daniel Lacalle, Chief Economist at Tressis Gestión and author of ‘Freedom or Equality,’ recently spoke with CNBC about what really drove the Fed’s pivot from tightening to loosening policy at the beginning of the year as well as whether or not we are approaching the limits of monetary policy. Mr. Lacalle argues that the Fed has been reacting primarily to asset prices, not economic fundamentals (as we have discussed here), and that they will continue to act aggressively to mitigate any catastrophic falls in assets prices, even if that means the Fed and/or ECB buying stocks outright.

Part I

Part II

Some excerpts from Daniel Lacalle:

“I think that the US data is going to continue to be a mixed bag of better than expected, actually in manufacturing, …but it is showing the signals of a late cycle slowdown. Nothing bad about it…”

“The Fed pivoted (in the fourth quarter of last year) because of the fall in asset prices. That was it. Not because of the data. If you look at the actions of the Federal Reserve, none of them have anything to do with the data. Actions have been preemptive because of what other central banks were doing, and not because of the growth, unemployment, or inflation. Core inflation (is) above 2%… The Fed reacted to asset prices and asset prices were reacting to the extremely aggressive perception of normalization that actually never happened…”

“Are we in a situation again where more bad news is going to be good news because it means central banks are going to be more dovish? Very probable, very probable, because the positioning of most investors… is actually less towards the consumer side of the economy. However, I don’t think the data is going to be bad. I think that the data is going to be decent. Nothing to write home about…”

“What monetary policy does from here is put a cap on the risk, but not much more. There can be a lot of things that central banks can do on top of what they are already doing. The question is: Will it work in terms of macro (data), in terms of inflation? …(It will avert) at least a massive asset fall…, or a prolonged one… Look at what happened between October and December of last year, synchronized asset prices fall all over the market. Central banks immediately react. But let’s think of how they reacted. They didn’t do a lot… the central bank balance sheets, both of the Fed, the BOJ, and the ECB didn’t change dramatically. What they did what basically just say to markets that the process of normalization was over, and that changed the perception of risk for most market participants very very quickly. I know it is dangerous, but… when the problem is that central banks have gone from the lender of last resort to the enabler of asset price inflation… if asset price inflation stops, it creates a domino effect that creeps into the real economy. And that is sort of the Catch 22 problem that central banks have put themselves into… The will react with more aggressive movement in terms of buying equities, buy corporate bonds… we’ll see.”

As we have noted previously, the Fed is transforming itself from a counter-cyclical force on the economy to a pro-cyclical force that is providing stimulus in an explicit attempt to “sustain the expansion.” As Mr. Lacalle notes, they will presumably do yet more stimulus the next time markets meaningfully tumble.

There is much more to the interview, so enjoy it above.

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