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Fed Risks Falling Further Behind as Inflation Roars

Fed Risks Falling Further Behind as Inflation Roars

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By Wednesday, 04 January 2017 09:04 AM Current | Bio | Archive

Bloomberg reports that the Chinese government has studied possible scenarios for their currency, the renminbi/yuan (CNY) because of continuous capital outflows and is preparing contingency plans.

Chinese regulators have already encouraged some state-owned enterprises to sell foreign currency of which the U.S. dollar is of course by far the most important one and may order these enterprises to temporarily convert some holdings into CNY under the current account if necessary.

China has been looking at capital outflows with particular attention.

Countries with fixed or semi-fixed exchange rate regimes tend to intervene because of movements in capital flows, not because of the current account.

China built huge foreign exchange reserves because foreigners chose to invest large amounts of money into China and that capital inflow needed to be offset if the CNY was to remain stable. Those capital inflows have now fallen significantly and tend to pressure to intervene in the foreign exchange markets to weaken the Chinese currency, which has also fallen significantly.

Now, the concern is the other way that with little foreign inflow and some domestic outflow the renminbi/yuan will come under too much pressure to weaken.

It probably doesn’t hurt that the idea of selling the dollar could be taken as a counter-threat to the protectionist rhetoric of the incoming U.S. administration, which is a situation that investors could do well keeping an eye on.

The widening of the CNY basket by adding 11 new currencies, although that necessitates no actual change in the composition of foreign exchange reserves, could also be viewed as a reminder that the dollar is not the only reserve asset available.

From the Euro area we got the first estimate of headline consumer price inflation (CPI) that came in at 1.1 percent for December and up from 0.6 percent in November.

No doubt this will give ECB President Mr. Draghi a lot to think about in the run up to the upcoming ECB Governing Council monetary policy meeting on January 19th.

Now, why is the headline CPI exciting? Because unlike most central banks, the ECB pays undue reverence to the headline raise of inflation. They claim it has something to do with the way pay deals are struck in the Euro area and it’s exciting today because there is every prospect that the Euro area headline inflation rate will rise to or indeed above 1 percent in year-on-year (y/y) terms.

This is because the distortion of the oil base effects is fading and underlying inflation pressures are coming through.

However, it is worth noting that the correlation of the underlying inflation pressures across the Euro area is extremely low.

Local forces shape inflation and the divergence in the performance of the various local economies in the Euro area means divergence in inflation experience, even if the oil effect will mean higher inflation for all.

The final Euro area composite PMI data coming in at 54.4 signals an even stronger end to 2016 than the preliminary flash numbers suggested, though whether this provides a much-needed springboard for the Euro area’s recovery to gain further momentum in 2017 remains very uncertain. Much depends on political events with elections in the Netherlands, France and Germany while snap elections in Italy and Greece cannot be excluded.

Chris Williamson, Chief Business Economist at IHS Markit commented: “The concern is that domestic demand is likely to remain subdued over the course of 2017 as political uncertainty dominates, resulting in another year of disappointing growth across the region as a whole. For the moment, however, companies are brushing off political worries, with optimism among service sector companies – who will arguably be the most affected by any political turmoil – reviving to one of the highest levels seen for over five years.”

From the United States, there are the minutes of the December FOMC meeting. A very momentous meeting given the political backdrop and the decision indeed to raise interest rates.

The obsession markets have over the dot-plot forecasts of the Federal Reserve is unhealthy. The minutes give a better, though still far from perfect idea of the nuances and subtleties of the Fed’s debate.

There is a risk that the Fed falls a little further behind the curve in 2017 as U.S. inflation pressures mount. The extent to which that sentiment is expressed in the minutes will be interesting to see.

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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The obsession markets have over the dot-plot forecasts of the Federal Reserve is unhealthy. The minutes give a better, though still far from perfect idea of the nuances and subtleties of the Fed’s debate.
federal reserve, inflation, economy, curve
Wednesday, 04 January 2017 09:04 AM
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