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Fed May Go Too Far This Year With 4 Rate Hikes

Fed May Go Too Far This Year With 4 Rate Hikes
Paulus Rusyanto | Dreamstime.com

Thursday, 01 June 2017 09:30 AM Current | Bio | Archive

It seems like climate chat has set the entire world abuzz.

The "climate" of global central-bank policy also seems to be changing, at least for the U.S. Federal Reserve and the European Central Bank.

San Francisco Fed President John Williams said he sees a total of three interest-rate increases for this year as his baseline scenario, but he won't rule out four hikes if the U.S. economy gets an unexpected boost.

"There is potential for upside occurrences in the economy. One big question mark is if there is big fiscal stimulus or other changes in the outlook that we see the economy is doing better than we thought," said Williams, who was speaking on the sidelines of a forum held by the Bank of Korea in Seoul, Reuters reported. 

In March the Fed lifted rates a notch, its third tightening since the 2007-2009 financial crisis and recession. Forecasts from Fed officials suggest a median of two more hikes are planned before year end, and futures markets are pricing in a roughly 90 percent chance of a 25-basis-point hike later this month to a range of between 1.00 percent and 1.25 percent, Reuters reported.

I think that is a little bit excessive. Four hikes plus a move to passive quantitative tightening of policy might be a step too far.

Nonetheless, it does signal that the Fed is keen to get back to some degree of policy “normality.”

Meanwhile, Jens Weidmann, president of the German Bundesbank and member of the ECB governing council declared that the European Central Bank is starting to debate whether to change its guidance.

No, it's not the end, but perhaps the beginning of the end of the ECB’s expansionary quantitative policy.

The roadmap for the ECB offers change guidance, stop buying bonds and allow the ECB’s balance sheet’s ratio to GDP to decline, which would in fact represent an organic tightening of its quantitative policy.

Meanwhile, the Fed’s Beige Book reported an economy that is performing perfectly normally albeit with shortages of labor, now starting to generate higher wages.

This is of course a normal reaction at a time of full employment.

Today, the world will be deluged with manufacturing opinion polls, known as Manufacturing Purchasing Indices (PMI).

The tendency for such Manufacturing Purchasing Indices to be answered inaccurately, to be subject to political bias for respondents to gain the system and thus for these surveys to overreact to the real world is now legendary.

At present, sentiment surveys are suffering of significant “overinflation.”

Investors could do well keeping in mind that the “deflation” of these data back to normality is on its way, and when that happens, it will not signal in any way an economic downturn.

In this context, investors should better not read too much into China's Caixin (private opinion poll) manufacturing purchasing managers’ index (PMI) that dipped to 49.6 from 50.3 in April, which is lowest reading since June 2016 while output fell to 50.2 vs. 51 in April.

The “official” manufacturing sentiment data showed surprising resilience, maintaining the 51.2 reading, while services inched up to 54.5.

Meanwhile, President Donald Trump tweeted that he will announce his decision on American participation in the Paris Climate Accord.

In the Financial Times, we read that Trump is poised to pull the U.S. out of Paris climate deal. 

What does this mean economically and for investors?

In one sense, the president’s momentous tweet is an irrelevance.

Any company that operates globally will be under pressure from customers, shareholders and foreign regulators to behave in an environmentally friendly manner.

This isn't quite the same as the constraints of regulation, but it does blunt the influence of the president. In many ways, corporates pursuing the profit motive may take the lead in issues like the environment or discrimination if the U.S. government retreats.

However, there are a few of ways that do matter.

In the United States, there are many companies that don't have a global reach, and indeed most U.S. companies have no global reach at all.

That’s more a comment on the dominance of the small and median size enterprise sector than it is a comment on poor U.S. export performance.

These companies will be less pressured by market forces, unless the domestic American consumer feels the consequences of an environmental credit crunch at first hand.

Besides all that, it now seems that the United States is creating an alliance between the European Union (EU) and China over environmental issues in reaction.

Both the EU and China have direct experience of the adverse consequences of the environmental credit crunch, which refers to a crisis (which may be economic in origin) which exposes humanity's inability to indefinitely consume finite natural resources in order to sustain economic activity and a standard of living.

Please take care, this not so much about the climate change accord itself. It is more about diplomacy and America’s place in the world. 

All that said, we will now wait and see what Trump will tell us later today.

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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San Francisco Fed President John Williams said on Thursday he sees a total of three interest rate increases for this year as his baseline scenario, but views four hikes as also being appropriate if the U.S. economy gets an unexpected boost.
fed, rate, hikes, john williams
Thursday, 01 June 2017 09:30 AM
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