The Fed’s strategy, the dollar and the emerging markets

The Fed’s meeting today is an opportunity to show the dramatic monetary policy divergence between the US central bank and the ECB and the risk for a stronger greenback.
The first graph shows the gap between monetary policies’ expectations in the two countries. The measure here is the 2 year rate in 1 year. The time scale begins with the Euro Area inception in 1999.
The divergence between the two central banks’ strategy has never been so important. It’s a strong support for the US dollar which will continue to appreciate and it’s a source of risks for emerging countries. The strong probability of a US tighter monetary policy in a foreseeable future will support capital outflows reducing liquidity on these markets. MPexpectationsdetail Continue reading

What the Fed Is Missing

A complement to my recent post on the signal brought by an inverted yield curve on the economic activity.

The Federal Reserve isn’t worried about the yield curve, and it has reason why. The problem: It is pretty much the same reason it wasn’t worried about the yield curve before the financial crisis.
— Read it here

A Former Central Banker Tells Other Central Bankers: “Stay Away From Davos” –

An interesting point of view on the role and the place of central bankers in the political spectrum.

In an interview with ProMarket, former Bank of England deputy governor Sir Paul Tucker explains why the “unelected power” of central bankers threatens our system of government.

Sir Paul Tucker
The European Central Bank found itself under renewed scrutiny this month, after Italy accused it of buying too few Italian sovereign bonds, allegedly in an effort to pressure the country’s new populist government to adopt more conventional economic policies.

The accusation was yet another example of the curious position the ECB has repeatedly found itself in ever since the central bank’s president Mario Draghi promised to “do whatever it takes” to preserve the euro in 2012. But it was also part of a larger, global wave of populist attacks against central banks. In Turkey, President Erdogan has repeatedly attacked the country’s central bank for raising interest rates, even going so far as to threaten the bank’s independence. In Britain, Environment Secretary Michael Gove has assailed the Bank of England and other central banks for their loose monetary policies, arguing that these policies benefited a small minority of “crony capitalists” who had “rigged the system” in their favor.

This political backlash came as no surprise to Sir Paul Tucker, the former deputy governor at the Bank of England and a research fellow at the Harvard Kennedy School of Government. Central bankers, Tucker writes in his timely new book Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State, have emerged from the financial crisis with enormous new powers, entrusted by governments with the ultimate responsibility of making the economic recovery work. This change, he writes, relied on the “false hope” that central banks can create long-term prosperity. It is also fundamentally different than the response to the Great Depression, which was led by elected officials, not central bankers. Their expanded responsibilities, argues Tucker, have also turned central bankers into the “poster boys and girls” of unelected power, a process which ultimately erodes the legitimacy not only of central banks, but also our system of government as a whole.

Tucker, the chair of the Systemic Risk Council, a non-partisan think tank composed of former government officials and financial and legal experts, is a lifelong central banker. His book, an ambitious tome that stretches over 656 dense pages, is both a philosophical treatise on the limits of the administrative state and a passionate call for fellow technocrats to heed the lessons of recent political upheavals, pull back their power, and engage the public in a wider debate.

We recently sat with Tucker, who visited the Stigler Center in May for a series of interrelated lunch seminars, for an interview on politics, regulatory capture, and central banking’s crisis of legitimacy.

Read the interview

Fed:+25 bp

The Fed has raised its main rate by a quarter-point. It is now in the range of 1.75-2%. Explanations are the strength of the business cycle and inflation close to the Fed’s target. Projections still suggest two rate increases in 2018, 3 in 2019 and 1 in 2020.

This is consistent with my forecasts but will lead to a flattening of the curve and therefore a higher probability of a recession in 2020.

The rules of the game have changed for emerging countries

The emerging countries’ environment is dramatically changing. It used to be an easy place to play but it is no longer the case. Stability in developed countries’ monetary policy was an opportunity for them. Their interest rates were higher and the spread with the US was a strong source of return.
What has changed?
The dollar, which was perceived as weak by many investors, now follows an upward trend. Since mid-April its effective exchange rate has appreciated by more than 4%. As it can be seen on the graph, it’s also a surge vis-a-vis the euro.  Continue reading

Oil, dollar, wages and unemployment in the US – my Monday column*

Oil prices are soaring out of control to slightly above $75/bbl, while the greenback is gaining ground again, and now stands at under 1.2 to the euro with its effective exchange rate rising swiftly and triggering uncertainty on the markets, particularly emergings.

Meanwhile, wages are still not rising in the US, despite unemployment falling below the 4% mark for the first time since December 2000: at the time, the reference wage was up 3.8% vs. an increase of merely 2.6% in April 2018.

Continue reading

The Fed increases its rate, but more to come

The Federal Reserve has increased its main interest rate by 25 basis points. The corridor for the fed fund’s rate is now [1.5 – 1.75%] versus [1.25 – 1.50%] since December 13, 2017. The dots graph which represents FOMC members’ expectations of the fed fund suggests that the US central bank will hike its rate 3 times in 2018 (already one is done), 3 times in 2019 but only twice in 2020. The rate’s profile contained in the dots graph is unchanged even if growth expectations are stronger according to these same FOMC members.
Continue reading