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Fed Has Every Reason in World to Justify December Rate Hike

Fed Has Every Reason in World to Justify December Rate Hike
(Dollar Photo Club)

By    |   Thursday, 21 September 2017 09:49 AM

The Federal Reserve did pretty much what they were supposed to do.

Fed Chair Janet Yellen essentially said during her news conference that a long-term commitment to quantitative-policy tightening has finally been put in place and that the quantitative-policy tightening will continue unless something seismic should happen in the economy.

This program will reduce the Fed’s securities holdings in a gradual and predictable manner.

This isn't unexpected.

There was also a relatively clear signal of an interest-rate increase at the December FOMC meeting.

And why not?

During the past 12 months, the “real” fed-funds rate has fallen as inflation has normalized. The inflation rate is considered on target by most economists, on target meaning in an acceptable band around the target, not hitting 2 percent with pinpoint accuracy that can never by achieved.

The United States’ labor market is strong and growth is around trend and the only abnormality in the U.S. economy today is the interest rates.

Still, we had a market reaction despite the Fed doing what economists expected. Foreign exchange markets saw a kneejerk reaction, albeit not too exaggerated, in the form of dollar strength.

Gold had a reaction in the other direction.

For investors, it might be helpful to recall that experience has taught us how FX markets react to a FOMC's balance sheet reduction as we have seen when the FOMC began tapering its QE program in January 2014.

Now, please take care, there is a serious probability that we could see a stronger dollar that moves in parallel over the next 12 months to the pace of the balance sheet reduction.

In the meantime, the National Financial Conditions Index should firm again.

Also on Wednesday, the Organization for Economic Co-operation and Development (OECD) released its updated Economic forecast summary (June 2017) for the United States. 

The report reads: “Economic growth is projected to pick up in 2017 and 2018 as headwinds from past exchange rate appreciations abate and support from fiscal policy begins to appear. Consumer spending will benefit from continued, though slowing, employment gains and, as the labor market tightens, stronger wage growth. With inflation nearing its target and unemployment edging down further, monetary policy stimulus has begun to be withdrawn gradually … Reducing the size of the central bank’s balance sheet will soon become appropriate … The present projection assumes no spending increase at the federal level, but a tax reform is projected, which will support consumer spending and investment in 2018.”

The Bank of Japan incidentally also did what was expected overnight with masterful inactivity in its chosen policy path deciding that the policy balance rate will remain at -0.1%, that the 10-year bond yields will be targeted at around 0% and that asset purchases will continue at around 80 trillion yen or about $710 billion a year.

With rumors of a general election being contemplated, it is hardly likely that the Bank of Japan (BOJ) would be raising rates. The Bank of Japan independence being perhaps a little more theoretical than real.

And no, we are not done with central banks yet, for there is the inestimable delight of hearing ECB President Mario Draghi. Draghi is speaking in Frankfurt, Germany at the General Council meeting of the ECB and his comments could be relevant for foreign exchange markets at a time that the ECB is expected to taper their quantitative policy at the start of next year, scaling back the amount of bonds bought.

At that same occasion, the ECB just released its latest Economic Bulletin that reads: “In the United States, activity is expected to strengthen. The recent depreciation of the US dollar and the pick-up in global growth are expected to boost the contribution of net exports to growth. Gains in housing and equity prices, coupled with buoyant consumer confidence and tight labor market conditions should all strengthen consumption spending further. With companies reporting improved earnings and solid business confidence, investment is projected to increase at a steady pace. However, market expectations of a smaller fiscal stimulus will provide less impetus to economic activity than previously foreseen.”

In summary, all this means that today’s remarks of Draghi that might have a bit of a dovish tone to them, which in conjunction of the Fed’s more-determent policy path may make an interesting comparison for markets.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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The Fed sent a relatively clear signal of an interest-rate increase at the December FOMC meeting. And why not?
federal, reserve, central, banks
Thursday, 21 September 2017 09:49 AM
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