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Fed Fear of 'New Abnormal' May Weaken Dollar

Fed Fear of 'New Abnormal' May Weaken Dollar


Thursday, 05 January 2017 08:22 AM Current | Bio | Archive


The release of the Fed's minutes of the December FOMC meeting showed the Fed giving tacit endorsement to the idea that we are living in the new abnormal.

The uncertainties about the policies of the new administration were acknowledged.

The problem is that past relationships and signposts for Fed policy do not really seem to apply to the incoming administration. This heightens uncertainty for all concerned.

The impression given is that the Fed will be more reactive than preemptive in setting its policy, and that the extent of Fed policy tightening is now contingent on the impact of fiscal policy.

That is a position that would certainly allow the Fed to linger a little behind the curve at a time that U.S. inflation slowly picks up.

As much of any fiscal stimulus that does come through is going to hit the U.S. economy in 2018 and not in 2017, the uncertainty about policy reactions may be more of a story for next year than this year.

The Fed minutes seem the acknowledge that the labor market in the United States is relatively tight. Wage pressures are clearly building with measures like the Atlanta Fed’s wage tracker being the most robust since the crisis.

Today, we are getting the ADP payrolls ahead of tomorrow’s (Friday) monthly employment report.

Unfortunately, like most big data this does not allow us to have a clear macro picture. The ADP payroll numbers are very far from perfect as indicators. Today’s figures will serve as a little more than background noise ahead of tomorrow’s (Friday) monthly employment report. Even tomorrow’s data may create more muted market impact.

If the Fed is signaling that the key variable in its policy reaction function is fiscal policy rather than fundamentals, then the Trump twitter feed could be more important than the economic facts.

The UK and the U.S. both offer service sector sentiment data today in the form of the UK's Purchasing Managers’ Indicator (PMI) and the Institute for Supply Management (ISM) opinion polls respectively.

Both countries have reasons for politics to intrude on the economic signals of these data.

In the UK, the service sector seems to be somewhat overlooked in the government’s bargaining with the European Union (EU). It is manufacturing that gets the attention because politicians seem to be stuck in a mindset that looks more appropriate to the patterns of 1840 when the UK, after having built the British Empire, abandoned mercantilism and engaged with practicing “free trade,” with no tariffs or quotas or restrictions. At that time, the powerful Royal Navy protected the UK’s global holdings, while its legal system provided a system for resolving disputes inexpensively.

That was then and certainly that is not the reality the UK has to face at this stage in the 21st century.    

Service sector concerns about the UK exit from the EU may be more significant therefore, but haven’t come through yet.

The just released Markit / CIPS UK Services PMI shows the rate of expansion of service activity accelerated for the third month running to the sharpest since July 2015, fueled by stronger growth in new work.

The survey also signals that inflationary pressures in the service sector remain substantial, with prices charged rising at the strongest rate since April 2011.

Investors could do well keeping in mind that the service sector will need a persuasive argument as the terms of Brexit are negotiated for the present broad-based recovery to be maintained in 2017.

For the U.S., the service sector has a different position. Politics in the U.S. is also focused on the manufacturing sector, but the protectionist bias puts manufacturing at a relative disadvantage to the service sector.

However, rising wage costs from the tight labor market may be a greater concern for U.S. service sector companies.

Finally, it’s interesting to see that the euro has risen (somewhat) against the dollar in the wake of the release of the FOMC minutes.

Investors should better not forget that the U.S. needs daily capital inflows of about $2.7 billion just to maintain a stable dollar and the Euro area needs capital outflows to maintain a stable euro. Anything that causes investors to “wait and see” will be a negative for the dollar.

If the Fed minutes have induced a note of caution and investors take that into account, then the daily $2.7 billion could be not right forthcoming and therefore the dollar could weaken because of that.

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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If the Fed minutes have induced a note of caution and investors take that into account, then the daily $2.7 billion could be not right forthcoming and therefore the dollar could weaken because of that.
federal reserve, dollar, minutes, uk
Thursday, 05 January 2017 08:22 AM
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