Tags: federal reserve | economy | investors | normal

Fed Expects 'Normalization Process' to Take 7 Years

By    |   Wednesday, 05 August 2015 08:31 AM EDT

St. Louis Fed President James Bullard, who will be a voting member of the FOMC in 2016, recently told the Wall Street Journal: “We are in good shape for increasing the Fed’s currently near-zero short-term rate target at the September 16-17 FOMC meeting.”

Interestingly, he didn’t seem worried about the employment-cost index rising last Friday by only 0.2 percent during Q2 (quarter-over-quarter), which was its lowest q/q performance in 33 years and that could indicate slack in the labor market as was the case in early 2009, but which apparently doesn’t seem to be the case today.

Atlanta Fed President Dennis Lockhart, who is a voting member at the FOMC, Tuesday told the Wall Street Journal when talking about the coming (at the September 16-17 FOMC meeting?) first increase in more than nine years of the federal-funds rates: “I think there is a high bar right now to not acting … it will take a significant deterioration in the economic picture for me to be disinclined to move ahead … the economy is in a state of readiness for beginning normalization.”

Of course, we’ll have to wait and see what the FOMC will decide in September.

However, there is no doubt the Fed’s first step — albeit very small — to “normalization” is coming nearer.

That said, Lockhart’s words caused the dollar to rise somewhat, but long-term investors shouldn't overlook the “Real Trade Weighted Dollar Index Against Major Currencies,” which shows the dollar still has to rise about 18 percent to reach the level where it was in Q1 of 2002.

As there is at present also a lot of noise about the negative impacts of a rising dollar on U.S. exports, it might be helpful to look at World Bank data that show U.S. exports of goods and services as part of GDP represents a rather small part of about 13.5 percent — especially when you compare that to China that stands at 22.6 percent, Japan at 16.2 percent, Germany at 45.6 percent, the U.K. at 28.4 percent, France at 28.7 percent, etc.

All this doesn’t mean the Fed’s path to normalization won’t have impacts on the global economy as a whole. Especially those emerging economies that are non-U.S. dollar producing economies and that have taken on way too much U.S. dollar denominated debt now world trade is apparently in contraction mode.

As for what the Fed’s path to “normalization” really means, there are the FOMC minutes of September 16-17, 2014, which give a rather good explanation.

We shouldn't overlook the fact that Federal Reserve Board economists expect the whole normalization process could take about seven years once it gets underway.

Taking that into account, I think it becomes high time the Fed starts raising its fed-funds rates for the very simple reason it is practically impossible there won’t be another financial crisis during the coming seven years.

At today’s rock-bottom fed-funds rates, there is literally no space whatsoever for substantially easing over a longer period of time in case that should become necessary once again over the median term.

Normalization should have mainly two important phases:

Firstly, there will be the lift-off.

Secondly, there will be the Fed ending its “reinvestment” policy so that the amount of interest-earning liabilities could shrink substantially and thereby its balance sheet would be reduced to such a level the Fed would have sufficient means to face another financial crisis.

Of course, shrinking the Fed’s balance sheet by not replacing maturing Treasury Securities and Mortgage backed securities is easier said than done.

Yes, to be successful the Fed will need a lot of lot of luck for at least a couple of years...

All that said, and about the Chinese currency joining the dollar, euro, Japanese yen and pound sterling as the fifth currency that compose the IMF Special Drawing Rights (SDR), the IMF staff states in a just released staff report: “Across a range of indicators, the RMB (renminbi or yuan) is now exhibiting a significant degree of international use and trading. At the same time, the four freely usable currencies (dollar, euro, Japanese yen and the pound sterling), generally rank ahead of the RMB.”

The staff report also calls on China to increase foreign access to its onshore stock and bond markets, especially government bonds.

The report concludes the IMF should put off any move to add the Chinese currency (RMB or CNY) to its Special Drawings Rights currency basket until September 2016.

The director of the IMF’s strategy, policy and review department is quoted by Reuters as saying: “The proposed extension, which will be decided by the Executive Board later this month, would not in any way prejudge the timing of conclusion or outcome of the review.”

About the Author: Hans Parisis
Hans Parisis is a regular contributor to the Financial Intelligence Report. To join the Financial Intelligence Report, click here. Click Here to read more of his articles.

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Of course, we’ll have to wait and see what the FOMC will decide in September, but there is no doubt the Fed’s first step, albeit very small, to “normalization” in coming nearer.
federal reserve, economy, investors, normal
Wednesday, 05 August 2015 08:31 AM
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