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It's Difficult, if Not Impossible, to Read the Fed's Mind

It's Difficult, if Not Impossible, to Read the Fed's Mind

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Monday, 26 October 2015 07:43 AM Current | Bio | Archive

Friday, China eased for the fifth time this year by cutting the benchmark rates on loans and the one-year deposit rates and lowered the reserve requirement ratio for its banks.

It’s clear that lowering the Chinese banks’ reserve requirement ratio is aimed at stimulating Chinese consumers to consume more. Question is if that will be the case and in this context, over the weekend we learned that rising vacancy rates and plummeting rents are increasingly common in Chinese malls and department stores, despite recent official data show a solid rebound in retail sales.

Chinese growth rates aren’t what its government wants us to believe they are, and that’s precisely the point long-term investors should keep in mind because this situation isn’t going to change any time soon, and the further slowing Chinese economy will continue to put the brakes on global growth.

That said, on Wednesday the FOMC will release its statement wherein, we hope, we could learn something more about the question if a December rate lift is still a possibility.

As monetary policy is for the moment really all that matters, and this is, unfortunately, not limited to the U.S., it might be helpful trying to look somewhat deeper into the facts the Federal Reserve will take into account over the coming days/weeks with, where possible, into some comparisons to what happened in the past.

We all know risks assets will probably remain bound, unless an accident happens, for the zones where they are in now thanks to monetary policies that will remain super-easy and not to fundamentals.

Most of the market participants haven’t found yet where the lower boundaries of monetary policy(ies) actually are, but we should better keep in mind that “zero” is not the lower bound.

It could be somewhat more helpful, for now at least, taking a look at what happened to the dollar after Draghi hinted what he probably will do in December and the People’s Bank of China (PBoC) eased for the fifth time this year.

Thursday, Draghi’s words made the euro to fall out of bed while the dollar was broad-based substantially stronger.

As we don’t have to expect the ECB as well as the PBoC will change their policy “intentions” over the short to median term, this brings us to the concerns the FOMC had and what we read in the minutes in the paragraph ‘Participants’ Views on Current Conditions and the Economic Outlook’: “In particular, the appreciation of the dollar since mid-2014 was still a substantial drag on net exports, and the further rise in the dollar over the intermeeting period could augment the restraint on U.S. net exports  … almost all participants anticipated that inflation would continue to run below 2 percent in the near term, particularly in light of the further decline in oil prices and further appreciation of the dollar over the intermeeting period.”

These lines suggest the Fed is becoming increasingly sensitive to the impact of a stronger dollar strength on the competitiveness of U.S. exports as well as on the inflation outlook.

We know it’s a fact opinions differ on the precise tightening impact of a stronger dollar since the summer of 2011, but it could be helpful highlighting some changes since that time.

Since then we have seen the gap that existed between headline inflation and the Fed funds rate disappearing.

We have also seen, but then since the summer of 2009 a continuous moderation of inflation expectations with the yield spread between 5-year Treasurys and 5-year tips close to the levels where they stood in the summer of 2009.

No doubt, the Fed won’t overlook these track records over the coming days/months and seriously question itself how much higher an actual tightening of its monetary policy could cause the dollar to strengthen further and cause the known undesirable impacts.

One thing is for sure, the answer to the question if the Fed will start its long path to normalization in December remains a very complicated and total “unknown.”

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HansParisis
One thing is for sure, the answer to the question if the Fed will start its long path to normalization in December remains a very complicated and total “unknown.”
investors, economy, fed, money
666
2015-43-26
Monday, 26 October 2015 07:43 AM
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