‘Good reason to believe’ inflation will rise: Fed’s Fischer

29 Aug 2015 | Author: | No comments yet »

Fed watching China closely, Fischer says.

Federal Reserve Vice Chairman Stanley Fischer said the U.S. central bank should not wait until it had reached its inflation goal before raising interest rates and voiced confidence price pressures would accelerate. “Given the apparent stability of inflation expectations, there is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further,” Fischer said in remarks prepared for a panel at the Kansas City Fed’s annual policy retreat in Jackson Hole, Wyoming. “With inflation low, we can probably remove accommodation at a gradual pace,” he said. “Yet, because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2 percent to begin tightening.” The Fed is monitoring the fallout for the U.S. from stock market turmoil spurred by concerns about a slowdown in China.

For Treasuries traders battered by the most volatile week since February, the biggest turbulence may still be ahead as a crucial U.S. report on August employment looms.Money is flowing out of China at a quickening pace, leading to Beijing selling currency reserves in what amounts to a global quantitative tightening.Absent loosening elsewhere, conditions for riskier assets, and for global growth, will get tougher.The People’s Bank of China piled up nearly $4 trillion of foreign assets in the decade from 2003 as dollars flowed in from trade and were invested in securities such as US Treasuries in order to keep the yuan from strengthening.

Now the money is going the other way, a trend which accelerated after China experimented with a devaluation and a new semi-flotation of its yuan.Whereas China had been spending down its reserves at a more than $500 billion annual clip in July, conflicting reports suggest the PBoC may have spent between $100 billion and 200 billion since the Aug. 11 currency regime shift. “The PBoC has been defending the renminbi, selling FX reserves and reducing its ownership of global fixed income assets. The PBoC’s actions are equivalent to an unwind of QE, or in other words Quantitative Tightening,” Deutsche Bank strategist George Saravelos wrote in a note to clients.Remember that the assets bought up and stashed away by the PBOC were larger than all of the Federal Reserve’s QE efforts combined. Equity markets have plunged amid wild swings, the dollar has strengthened and commodity prices have fallen. “At this moment, we are following developments in the Chinese economy and their actual and potential effects on other economies even more closely than usual,” Fischer said.

Yet as stocks rebounded, U.S. debt ended the week with the biggest losses since June. “The markets are not used to seeing this level of uncertainty,” said Aaron Kohli, an interest-rate strategist in New York at BMO Capital Markets, one of 22 primary dealers that trade with the Fed. “We are at the precipice for a hike. Economists at BNP Paribas said “it seems obvious that the data released in the next two weeks will give almost no information to reduce that uncertainty since they will almost entirely relate to the period before the market correction.” The Fed wants to see further improvement in labor markets and be reasonably confident inflation is moving back toward its 2% annual rate target before hiking rates.

The benchmark 10-year note yield rose about 14 basis points on the week, or 0.14 percentage point, to 2.18 percent, according to Bloomberg Bond Trader data. Policy makers, who have held rates near zero since 2008, must judge if the U.S. economy has sufficient momentum to shrug off weaker growth abroad as they weigh the timing of liftoff. On inflation, “with regard to our degree of confidence in this expectation, we will need to consider all the available information and assess its implications for the economic outlook before coming to a judgment,” he said. Weak demand at Treasury auctions Tuesday and Wednesday were marked by weak demand from ‘indirect bidders’, a category into which foreign central banks fall.As well, Treasury prices haven’t moved as they usually would during signs of financial stress. A dimmer outlook for world growth has pushed commodity prices lower, potentially creating another headwind for feeble U.S. inflation, which has been beneath the Fed’s 2 percent target for more than three years.

The same is true for the fall in oil prices, through the most recent declines this summer have yet to fully show though, he added. “To think policy makers will be more confident [about inflation] in September than there were in July is ridiculous,” economists for the bank said in a research note. Despite their safe asset status, 10-year Treasury yields, now around 2.17 percent, are actually up by four basis points, with prices moving down, since China’s currency shift Aug. 11. On the other hand, U.S. gross domestic product growth was better than expected in the second quarter at a 3.7 percent annualized rate, and monthly job gains have averaged a solid 211,000 so far this year. The jobs report may lead traders to add to bets that the Fed will pull the trigger the following week and boost its target for the first time since 2006. Outbound money is partly direct and indirect investment flows, and partly money controlled by private Chinese citizens seeking a safe haven, both from more difficult financial conditions at home and also from the threat of seizure via official action.

It will probably show the economy added more than 200,000 jobs for a fourth straight month, while the unemployment rate dropped, according to the median forecast in a Bloomberg News survey. At the same time, the heavy-handed but ineffectual support of the stock market managed to inspire fear, with arrests of short-sellers and a financial journalist, but not confidence in official control. Fischer discussed various forces that he said have restrained U.S. inflation, including declines in energy prices, softness in non-oil commodity prices, a strengthening of the dollar and “ongoing economic slack.” Despite improvement in the labor market, “we have seen no clear evidence of core inflation moving higher over the past few years,” Mr. Fischer’s comments followed New York Fed President William Dudley’s remarks Wednesday that market turbulence made the case for a September move “less compelling” than a few weeks ago. China’s reserve stockpile is well above what the IMF recommends in similar situations, if we define China as having, more or less, a fixed currency with no capital controls.“In a nutshell, the PBoC’s war chest is sizeable, no doubt, but not unlimited.

But such movements “can be hard to interpret” and “may reflect factors other than inflation expectations, such as changes in demand for the unparalleled liquidity of nominal Treasury securities,” he added. The reality may well be that after more than a decade of attracting capital flows and stimulating global financial conditions, China, along with the rest of the world, may see a long period of the reverse.Rather than a bubble popping, the correct metaphor may be a long, slow deflation.

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