Expectations of 2015 Fed rate hike nudge dollar higher

28 Sep 2015 | Author: | No comments yet »

Column: Back to a better reality.

The dollar edged back towards a five-week high against a basket of major currencies on Monday, as investors eyed U.S. payrolls numbers and Chinese data later in the week for confirmation of bets the Federal Reserve will hike interest rates this year. A gauge of the greenback rose the most in two months after Federal Reserve Chair Janet Yellen clarified that she was one of the policy makers who believe an interest-rate rise would likely be appropriate this year.

US Fed Governor Janet Yellen’s act at the last Federal Open Market Committee (FOMC) meeting on September 17—coincidentally, the day that Ganpati arrived—was almost perfect. It left markets completely confused about whether the Fed was really concerned about global (and, by reflection, US) growth, as a result of which markets tanked; or whether it merely believed it needed to wait a little longer to end monetary accommodation, as a result of which markets recovered the next day.

An Oct 2 jobs report is projected to add to the central bank’s case for reducing monetary stimulus. “Faster hiring would pull a Fed rate hike into sharper focus and have the dollar poised for outperformance,” said Joe Manimbo, who is an analyst with Western Union Business Solutions, a unit of Western Union Co, in Washington. The Bloomberg Dollar Spot Index, which tracks the currency against 10 major peers, rose 1% this week in New York, the most since the five days through July 17.

I say “perfect” because, contrary to practice and belief over the past 20 years or so, it is not the Fed’s job to tell people what they are thinking. The Norwegian krone, which tumbled after the country’s central bank reduced its main interest rate, posted the biggest loss against the dollar this week. Transparency is, in principle, a good thing, but not in situations where it ends up underwriting risk, the cost of which is ultimately paid by taxpayers.

The Labor Department will release a report that shows employers added 202,000 jobs in August, according to the median forecast of 73 economists surveyed by Bloomberg. BNP Paribas’ Lynton-Brown said a vote in Catalonia that saw secessionists win a majority of regional parliamentary seats would have little impact on the euro.

I say “almost” because I believe the Fed should have raised rates, not to quell uncertainty but because near-zero rates encourage building up of ever more debt, which puts continuing downward pressure on growth. Traders are pricing in a 18% probability of the US central bank raising the benchmark rate by its October meeting and a 43% likelihood by the December meeting, according to data compiled by Bloomberg. Again, super low interest rates distort the already heavily skewed income distribution, as already noted by Governor Yellen, which leads to lower demand, which, again, leads to lower growth.

Thursday’s China Caixin Purchasing Managers’ Index (PMI), however, will be more closely watched than usual by currency traders, who reckon a sharply slowing Chinese economy could delay Fed rate hikes. “We have two big events this week. There is little doubt that the extremely slow recovery from the financial crisis of 2008 is largely the result of the huge amount of debt that was infused into the system through multiple rounds of quantitative easing. Chinese data now seems to be classified in the payrolls category of events,” said Mitul Kotecha, head of Asia-Pacific FX strategy for Barclays in Singapore. “There’s (a) reason not to be doing anything until you see these two big numbers.” The dollar has added 9.1% this year, the second-best performer behind the Swiss franc among 10 developed-nation counterparts, according to Bloomberg Correlation-Weight Indexes. But, returning to my oft-articulated point, central banks, rather than pandering to the financial markets with faux transparency, should actually be strong and silent, like God: You know he (or she or it) is there—if you are a believer—but you only see him (her/it) in an emergency, not every two months plus multiple speeches and interviews and certainly not as the largest player in the market.

He was loudly vilified by many at the time—in fact, he became the first Fed Chairman with a loud media presence—but his effort was eminently successful. Hard as it is to model the behavior of a free-market economy, it becomes impossible when one inserts 12 individuals, driven by their individual senses of social responsibility and vague statutory instructions. I’m glad the members of the FOMC are not allowed to let their own financial benefit guide their judgment on interest rates, but the fact remains that economics is built on the model of rational actors proceeding in their self-interest. True, but certain fundamentals—gravity, for instance, or the certainty that if you continue to pile up debt and remain oblivious to risk, you will meet a difficult end—have not and will not change. Rather, for 40 years, the Fed has operated under a mandate from Congress to seek “maximum employment” and “stable prices.” In reality, the Fed has reinterpreted the second mandate to mean a “steady rate of inflation,” rather than “no inflation,” which the words “stable prices” might otherwise connote.

In a recent (June 2015) interview, he spoke about how the financial sector had “become too big for its britches” and was the prime force in pushing inequality higher and destroying the American dream. Further, in contemplating a rate hike at its Sept. 17 meeting, the Fed realized that raising rates might slow down employment growth a bit but, unless the Fed eventually increases interest rates, it won’t have anything to lower to deal with the next downturn. Sure enough, financial firms’ profits (in the US) as a percentage of GDP, which had held broadly steady around 1.5%, started climbing in the mid-1980s, peaking at nearly 3.5% before the bubble burst in 2008. Additionally, financial assets in the US form fully 65% of total assets, far higher than any other country in the world (except, oddly enough, South Africa) and financial markets dominate 24-hour news broadcasts, turning otherwise sober economists (and Fed Chairmen) into rock stars. Fortunately, Ant Janet (as I like to call Governor Yellen) appears to be made of a different cloth than her immediate predecessors—more like Mr Volcker and our own Dr Reddy.

She isn’t really looking to be the Lady Gaga of the finance world and doesn’t need to expose her views with any greater degree of clarity than she has been doing. The bill also would direct the Fed to create conditions where all those seeking full-time jobs could get them, and where wages would rise with productivity. She needs to report to Congress, of course, but not yield to the bleating demands from the market, which will surely get louder, particularly if she really does this part of her job right.

There will be a period of heightened uncertainty at first—and this may last a while since it will be difficult for markets to get accustomed to the new “don’t ask don’t tell” Fed—but, in time, markets will return to a saner disposition. Risk will again start getting more correctly valued, the financialisation of the global economy will reverse, capital allocation will improve, and real growth will finally re-emerge. The Nobel committee should consider redirecting the prize from economics to psychology, and award that new Nobel to the researcher who creates a model of how the Fed behaves – one on which markets can rely.

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