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Investors Must Beware Central Bank Tightening

Investors Must Beware Central Bank Tightening

By    |   Monday, 26 February 2018 11:02 AM

The Federal Reserve has released its semiannual Monetary Policy Report.

New Fed Chair Jerome Powell, who is a lawyer and not an economist, is going to testify Tuesday before the House Financial Services Committee while on Thursday he is scheduled to testify before the Senate Banking Committee.

The 63-page report reports:

  • “… wage growth has been moderate, likely held down in part by the weak pace of productivity growth in recent years … Real gross domestic product (GDP) is reported to have increased at an annual rate of nearly 3 percent in the second half of 2017 after rising slightly more than 2 percent in the first half. Consumer spending expanded at a solid rate in the second half, supported by job gains, rising household wealth, and favorable consumer sentiment. Business investment growth was robust … The housing market has continued to improve slowly. Foreign activity remained solid and the dollar depreciated further in the second half, but net exports subtracted from real U.S. GDP growth as imports of consumer and capital goods surged late in the year … Vulnerabilities in the U.S. financial system are judged to be moderate on balance. Valuation pressures continue to be elevated across a range of asset classes … Leverage in the nonfinancial business sector has remained high.”
  • “… the ongoing strength in the economy will warrant further gradual increases in the federal funds rate…”
  • “Under currently enacted legislation, which includes the Tax Cuts and Jobs Act (TCJA) and the Bipartisan Budget Act, federal fiscal policy will likely provide a moderate boost to GDP growth this year.”

It is not expected that the Fed Chair will surprise the markets. Anyway, we’ll see if the new Fed Chair confirms or not, in some way or another, that the Federal Reserve is bound raising rates 4 times this year and that it will continue along its pre-determined path of quantitative policy tightening.

2018 could become the year of, in some way, simultaneous central bank tightening, which for investors and thus for markets is extremely important.

The European Central Bank (ECB) is also expected to start tightening, in its way of course, quantitative policy, which would mean that its balance sheet is likely to grow more slowly than GDP, in other words, money demand will outstrip money supply. Investors could do well keeping in mind that if this kind of policy were to continue beyond September, that could impact the euro.

The Bank of England has raised rates and probably will raise interest rates again this year. Earlier this month, the Bank of England (BoE) has signaled that interest rates are to rise sooner than previously thought as it upgraded forecasts for UK growth. Market predictions are that the next rate rise may come as early as May. The prospect of higher rates continues the slowly drift away from an era of easy, cheap money, which has been in place since the financial crisis nearly 10 years ago.

Of the major central banks, only Japan, waiting for wage growth, is staying away from the rate tightening party.

Today will be mainly about central bank speeches from the Fed and the ECB.

We have St. Louis Fed President James Bullard who is going speak on the U.S. Economy and Monetary Policy at the 34th Annual NABE Economic Policy Conference in Washington, which could be interesting as there is also a Q&A session planned.

Over in Europe, ECB President Mario Draghi will speak before the European Parliament in Brussels, Belgium.

The question is whether these central bankers speak for their institutions or whether they are out of the mainstream tightening process.

Politics is also providing some background noise to the markets today with China proposing to let President Xi Jinping extend his presidency beyond 2023.

The Chinese news agency Xinhua reported on Sunday: "The Communist Party of China Central Committee proposed to remove the expression that the President and Vice-President of the People's Republic of China 'shall serve no more than two consecutive terms' from the country's Constitution." No other details were given. The full proposal will be released later.

This means that China’s President Chi has cleared the way to go on and on and on in office by removing term limits on the presidency.

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

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The question is whether these central bankers speak for their institutions or whether they are out of the mainstream tightening process.
investors, central, bank, tightening
Monday, 26 February 2018 11:02 AM
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