The Federal Reserve needs to start shrinking its balance sheet to control inflation. Most inflation measures are currently running above their long-term averages.
The big question is about on how to move best from today’s “organic” quantitative tightening towards a more rapid pace of “passive” quantitative tightening.
This is an important debate as the Fed’s actions will have an impact on financial markets in the U.S. as well as in all economically important places in the world.
Cleveland Fed President Loretta Mester, speaking about the economic outlook and monetary policy in a prepared speech, said: “If economic conditions evolve as anticipated, I believe further removal of accommodation via increases in the federal funds rate will be needed … This upward policy path will help prolong the expansion, not curtail it. It will help avoid a build-up of risks to macroeconomic stability that could arise if the economy is allowed to overheat and risks to financial stability, should overly low interest rates encourage investors to take on excessively risky investments in a search for yield. It will put monetary policy in a better position to address whichever risks, whether to the upside or downside, are ultimately realized.”
There is no doubt that Mester’s message of gradual rate increases is probably not going to change that much. The monetary-policy pillar of the Fed’s policy isn't where the interest now resides.
The quantitative pillar is of more interest.
That said, the data from the U.S. today are relatively unimportant.
In an ideal world, the National Federation of Independent Businesses small business survey (NFIB) should matter.
Small businesses dominate the U.S. economy. They account for around 70 percent of private sector employment. The large listed companies of the S&P are, economically speaking, a sideshow.
However, the NFIB survey is a “survey” that is prone to overreaction and chronic unreliability like most surveys.
What is worse, the NFIB is a lobbying organization with all the potential for political bias that this entails.
In the past, there has been a suggestion that NFIB members answer survey questions more in line with the political or lobbying bias of the NFIB than with the actual economic reality.
Out of the euro area, we just got the German trade balance data that posted a trade surplus of 25.4 billion euro or about $28 billion dollars with exports as well as imports coming in stronger than expected and above all, exports hitting their highest number on record.
Now, trade data from what is essentially a province, albeit the biggest province of the Euro empire, should not cause a great deal of concern. However, as trade is a topic that appears on the Trump twitter feed from time to time, and as Germany has been singled out, for example when German Chancellor Merkel visited President Trump at the White House in March, a strong German trade position is not necessarily a “good” trade position.
Besides all that, and as there is a lot of talk on where the value of the dollar could go over the median term, investors could do well to recall that the “destination-based cash flow tax (DBCFT)” is a form of border adjustment tax (BAT), which is currently under consideration in the House of Representatives and that was proposed by the Republican Party in their 2016 policy paper “A Better Way — Our Vision for a Confident America,” which promoted a move to that form of tax.
The St. Louis Fed published on Monday a study under the title “The Destination-Based Cash Flow Tax and the Value of the Dollar,” wherein we read, “Because the taxes on imports and subsidies for exports would make U.S. goods less expensive relative to their foreign counterparts, economists and business analysts expect the U.S. dollar to appreciate by 25 percent in real (i.e., inflation-adjusted) terms.”
Of course, nothing is written in stone, but as an investor, I would prefer to keep that in mind …
Etienne "Hans" Parisis is a bank economist who has advised global billionaires and governments on the financial markets and international investments.
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