Fed Officials See Interest-Rate Increase on Track for 2015

29 Sep 2015 | Author: | No comments yet »

Column: Back to a better reality.

The Federal Reserve will probably raise interest rates later this year and tighten policy gradually thereafter, New York Fed President William C. The last report, entitled “Too Hot And Too Cold Is The New Just Right”, suggested that policy makers in advanced economies need to frame the current deflationary headwinds, from China and emerging markets, as tailwinds in the form of lower commodity input prices.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. This wealth transfer could then serve as the platform on which to base future economic growth and prosperity, rather than on the false economy of asset bubbles created by experiences with QE to date.

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 OECD is giving this thesis even stronger momentum by declaring war on the alleged $200 billion per annum fossil fuel subsidies in the advanced nations.

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.

Dudley, who cautioned in late August that the uncertain global outlook made the case for a rate increase in September less compelling, said his expectation on the timing of liftoff was “not calendar guidance. 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.

It is timely that this neoclassical view is being introduced because market observers have evidently lost their faith in central bankers’ abilities to create growth and inflation. 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. That’s based on my view of how the economy is likely to evolve.” That includes developments abroad, particularly in China, where slowing growth has sapped commodity prices, which is helping to suppress U.S. inflation.

The big takeaway from the post FOMC announcement price discovery was not the immediate squeeze higher in risk asset prices, but the capitulation selling pressure that came in as the squeeze could not be maintained. 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. Concern over the outlook for the world’s second-largest economy have roiled financial markets since China’s surprise currency devaluation on Aug. 11. 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.

More worrying is the fact that the central bankers actually have no faith in the returning neoclassical story either, and see a return of it as a wider global policy failure that they must now address. 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.

Yellen last week discussed allowing U.S. unemployment to fall under the level that Fed officials estimate to be full employment to draw more workers back into full-time employment. “We are going to go quite slowly,” he said, citing forecasts submitted by policy makers for the Sept. 16-17 FOMC. The previous article, entitled “A Mean Reversion To Exter’s Inversion”, explained how this loss of faith manifests itself as a migration of investors, down the levels of Exter’s Inverted Pyramid to its base.

Central bankers, meanwhile, indulge in various strategies aka “unorthodox monetary policies” in order to assault the value of gold and paper money at its monetary base so that investors are forced back up the pyramid scheme. 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. Having successfully framed the situation, the need for central banks to do further QE will be negated as will the need for them to embark on radical increases in interest rates also. 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. Even in my own projections, where I have mid-2016, we are getting closer,” he told reporters after delivering a speech in Milwaukee. “We’ve made a lot of improvement on the labor market.”

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. 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. 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 “dot plots” and the continued downward slope in the central tendency growth projections both suggest that the Fed is quietly moving to establish acceptance of this new low inflation paradigm.

Clearly, the Fed needs some ammunition to address this falling inflation picture, but the current low level of interest rates does not provide such a policy reserve. There are signs that consensus is now being created that US Treasuries represent fair value and hence a stable benchmark yield curve to start adding risk premiums for other asset classes. The conclusion to be drawn is that he is indicating that the Anglo-Saxon central banks and some within the ECB view the return of neoclassical economics with great horror.

Based on her equivocal Amherst speech, Janet Yellen also subscribes to Haldane’s view, although she is unwilling to wave the red flag as violently for fear of triggering the next “Credit Crunch”. According to Broadbent, non-skilled immigration has kept a lid on English wages thus far into the recovery, which will now allegedly rise to reflect an underlying skill shortage. In fact, it suggests that Britain has morphed into a low-skilled, low-growth, low-productivity economy since the Credit Crunch, which, in fact, plays into Haldane’s hands. Cunliffe neglected to inform that these higher interest rates may, in fact, be required to address the low productivity that Broadbent was alluding to.

The German government continued to push back on the ECB’s oversight and control of German banks by promoting a bill to place this power back within the Finance Ministry. In a cascading domino effect, the ECB’s Ewald Nowotny then pushed back against the Basel rules on capital adequacy by pushing for weaker rules in relation to European corporate loans. These red flags have evidently been seen by Citigroup’s head of G10 currency strategies, as has the growing creep towards Keynesian policies in the face of neoclassical fundamentals. The process of interest rate normalization in America and divergence with other G10 nations must now run its course to see if Englander’s prediction comes to fruition.

Chancellor Osborne risks making the UK situation worse by responding to a political red flag threatening the government in a way that puts the Bank of England under greater pressure. ECB Board member Peter Praet framed this debate succinctly when he opined that the ECB “won’t hesitate to act” if Mario Draghi concludes that expanding output and consumption at falling price levels represents a breakdown in the global order of things. Lithuania’s ECB Governing Council member Vitas Vasiliauskas suggested that the decision on further QE should be put on hold until December and the new economic projections that it heralds. Imprisoned within the Eurozone, Italian Prime Minister Renzi is also trying to work the optics to frame his own economy in terms of rising real rates of economic growth. Having been sidelined on further “QQE” by the IMF and G20 Ankara, the BOJ has had to sit by whilst the Yen strengthens and its equity market unravels.

The final nail in the coffin for Prime Minister Abe followed his latest piece legislation to re-militarise the country, which has seen his popularity fall to a new low. Last week, the BOJ began to send out signals that it too is indulging in the same great debate that is gripping the central banks in all the advanced economies. Governor Kuroda has already signalled that he intends to cut the rate of interest on balances held at the BOJ, but this policy tool already looks impotent. Having questioned China’s credibility and authority to lead G20 before the G20 Ankara summit, Secretary Lew then provided some wiggle room on the eve of Xi Jinping’s historic visit to America. The IMF has already reached out to embrace the destructive global competitive devaluation race to the bottom that the original Yen devaluation has triggered, as China has threatened to follow this precedent with a big devaluation of its own.

Given the re-emerging interest in Keynesian policies of late, suggested in the reports, entitled “Courageous Convictions Get Tested Further” and “Jackson Dip” , the IMF will no doubt be reaching out to take control of this subject very soon by making sure that nations following Keynesian policies are applying commensurate supply-side economic reforms to their economies simultaneously. Secretary Lew’s latest suggestion that China should combine a new fiscal stimulus with further economic reforms neatly elucidates the IMF’s prescribed wiggle room. Liu He, deputy head of the National Development and Reform Commission (NDRC), then provided a few extra details so as to avoid further criticism from Japan for the lack thereof. According to Liu He, mixed-ownership reform will soon be implemented by the central government in more than seven domestic industries among the state-owned enterprises (SOEs), including electric power, oil and gas, railways, civil aviation, communications and military industries. Xi’s polite American hosts kindly refrained from pointing out upon his arrival in America that the bailout of SOE National Erzhong Group signals that there is no sign of any said economic reform to date.

China will also tick the box for SDR basket entry by opening up its capital account in a proposed joint linking of the British and Chinese stock exchanges.

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