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Fed Is No Longer Just a 1-Trick Pony

Fed Is No Longer Just a 1-Trick Pony

Tuesday, 10 January 2017 07:22 AM Current | Bio | Archive

Ahead of tomorrow’s press conference, the Trump Twitter feed has been active. However, the opinions of the President-elect on the acting abilities of Meryl Streep are not necessarily market moving.

Instead, there are some more interesting stirrings in the policy arena that investors might like to pay some attention to.

Eric Rosengren, President of the Boston Fed commented yesterday on the need to consider reducing the Federal Reserve’s balance sheet as a tightening instrument, at least under certain circumstances.

He said: “The central bank’s balance sheet has been roughly level over the past two years … As part of the monetary policy normalization strategy, the FOMC should, of course, continue to consider whether it needs to maintain such a large balance sheet. (Ref. https://www.bostonfed.org/news-and-events/speeches/2017/current-economic-conditions-and-the-implications-for-monetary-policy.aspx#collapse2).

This is important for 2 reasons:

First: This reminds investors that the Federal Reserve is no longer a one trick central bank. Central bank policy is not just monetary policy anymore. It is monetary or interest rate policy, quantitative or balance sheet policy that, by the way was installed between 2009 and 2014 and was called quantitative easing (QE) and whereby the Fed started buying (in 3 rounds) U.S. Treasury securities, agency debt, and agency mortgage-backed securities (MBS) and finally, the Fed must also comply with its role as a regulator.

Regulatory policy can be thought of as a tax on banks and savers for the purposes of economic assessment.

Second: Rosengren raising the issue of the Fed’s balance sheet is a reminder of the multiple fault lines that exist within the FOMC. Investors can no longer think of the Federal Reserve as an institution of hawks versus doves in a tillable context because central bank policy and thus the divisions over its policy are a lot more complex than many tink.

Someone like the Fed Vice Chair Stanley Fischer will likely agree with Rosengren in emphasizing the balance sheet as a policy tool. That view is unlikely to be shared by the Fed Chair Ms. Yellen. It makes the interpretation of Fed policy more complex and it highlights the dangers of fixating on things like the dot-plot forecasts as those do not necessarily reflect the true stance of the FOMC membership with regards to policy overall.

Meanwhile, according to the NY Federal Reserve survey of consumer inflation expectations are rising.

For the most part this does not matter. Consumers are absolutely useless at predicting inflation because their perception of inflation is entirely dictated by the prices of things that they buy regularly.

However, inflation expectations can matter when consumers have pay bargaining power as employees.

If the labor market is tight, as it is in the States at the moment, then rising inflation expectations from consumers may lead to higher wage demands and higher wage demands will themselves lead to higher inflation in reality. This is not because consumers are good at predicting inflation. It’s because in those circumstances, consumer expectations can change economic reality, which is a legitimate concern this year in the U.S.

Chinese consumer and producer price inflation has been released with lower than expected consumer price gains (2.2 percent y/y) and higher than expected producer price gains (5.5 percent y/y). (Ref. https://pbs.twimg.com/media/C1yjcBlWgAAC4Fx.jpg)

Things like pork prices do help to moderate consumer prices this year and they are supreme in difference to the rest of the world. Never forget that China is not being noted as a food exporter.

Producer prices matter more and as much as these may have some bearing on export prices in certain sectors. However quite a lot of the gains in producer prices are due to supply being cut in certain heavier industrial sectors and that is a situation that may not last in the coming spring months.

Nonetheless, higher producer prices do reflect the pricing power that most of the listed companies experience.

The translation to the rest of the world is minimal however as Chinese export prices are nothing more than a tiny part of foreign consumer prices. They barely even register as a rounding error. 

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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Regulatory policy can be thought of as a tax on banks and savers for the purposes of economic assessment.
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Tuesday, 10 January 2017 07:22 AM
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