Tag Archives: Fed

Did the Markets Overlook Fed Bullishness in the March 16 FOMC Statement?

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Financial markets reacted to the outcome of the Federal Open Market Committee meeting on Wednesday, March 16, as if what the Fed had revealed was highly dovish, that is, diminishing expectations regarding future interest rates.   Dollar down, stocks and bonds up…  According to Goldman Sachs, the markets reacted as if this were among the top 4 surprises in Fed dovishness since the turn of the century (not counting reactions to the GFC).

The markets were looking at a shift in the “dots plot.”  The shift formally rescinds the Fed members’ previous forecast that supposedly they would raise interest rates four times in 2016.  (Now it says twice.)  Furthermore, Chair Yellen in her press conference said, “Most Committee participants now expect that achieving economic outcomes similar to those anticipated in December will likely require a somewhat lower path for policy interest rates than foreseen at that time.”

But this is old news. It reflects developments at the start of the year, such as the Commerce Department report that GDP growth had been weak in the 4th quarter and the global financial market volatility in January and early February (especially related to China).  Everyone knew all this a month ago.

The new news pertains to what has happened since mid-February.  A lot of trends that had appeared to be negative have reversed in the last month.  Statistics on US domestic final sales in January suggest that GDP will likely be stronger in the first quarter. Meanwhile, job gains were back up to 242,000 in February, reaching a record six-year-long streak of private employment growth.  And globally, downward pressure on the renminbi, the US stock market, and commodity prices — which had so worried investors – all abated in February-March.

So did the Fed recognize these signs of economic strength in its statement Wednesday?  Yes, it did.   Gone was the January sentence “…economic growth slowed late last year.”   In its place was a note that “economic activity has been expanding at a moderate pace…”   (Also “Inflation picked up in recent months.”)  Unless I am mistaken that language wasn’t there before, only the longstanding positive language about employment.  It seems to me that the markets this week may have missed an acknowledgement from the Fed that things have turned around since the first six weeks of the year.

[Comments can be posted at the Econbrowser version.]

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The Fed, China and Oil

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My answers to three questions at the start of 2016 (from Chosun Ilbo, leading Korean newspaper):

1. How do you analyze the recent US interest hike, and how will it influence the global economy in the coming year?

The Fed had telegraphed its decision to raise the interest rate so far in advance and (by December) so clearly, that the policy change was already fully reflected in markets.  For example most of the substantial appreciation of the dollar since 2014 can be attributed to anticipation of the Fed tightening.   Furthermore, the movements in relative monetary policy — the end of quantitative easing in the United States, the first increase in interest rates, simultaneous monetary easing in other countries and the appreciation of the dollar – all reflect relatively greater strength in the US economy compared to most others.  It will create difficulties for some commodity-producing countries that had gone back to large-scale borrowing in terms of dollars.  But the pattern of US growth, monetary tightening, and dollar appreciation is not bad news for the rest of the world overall.

 

2. What is your view on China’s economy, and how will it economy influence the global economy this year?

It was inevitable that China would not be able to sustain a fourth decade of growth rates in the neighborhood of 10%.   Some of the sources of its growth have begun to run into diminishing returns, such as rural-urban migration, heightened capital/labor ratios and an over-stretched environment.

The open question is whether the transition to a more sustainable and moderate rate of growth that we are now seeing will be a soft landing or a hard landing (e.g., a crisis arising from unneeded construction, shadow banking, and bad loans).   A good scenario, the soft landing, is by no means ruled out yet.  The 2015 stock market bubble and crash was not as important as observers thought.  Much of what we are seeing could be the desired shift in the composition of China’s economy, away from the production of manufactured goods and their sale for exports or physical investment, and toward the production of services and their sale to the consumer sector.

Even though China is slowing down a lot, its economy occupies a much larger share of the world economy than it used to.  For this reason, it will continue to be an engine of growth in the world, just not as quite as strong an engine as had been forecast by those who rely on simple extrapolation of past trends.

3. What is your view on oil prices recently? How will the oil price change impact the global economy this year?

The fall in dollar oil prices has many causes, both on the supply side (US fracking, Saudi decisions) and the demand side (weakened demand from much of the world, especially China).   One cause that is often overlooked is the strength of the dollar against other currencies.

Needless to say, the fall in oil prices hurts oil exporters and benefits oil importers.   The benefits for oil importing countries in Asia and Europe in 2016 will probably be greater than what has been evident so far.

Low retail prices for fossil fuels are bad for the environment.  All countries should take advantage of the recent fall in oil prices by either shifting their taxes onto fossil fuels or else, if they currently have wasteful subsidies to fuel consumption, then they should cut them.  They should take their cue from developing countries such as Egypt, India, Indonesia, Mexico and the UAE that have done that recently.

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Does the Dollar Need Another Plaza?

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We are at the 30th anniversary of the 1985 Plaza Accord.  It was the most dramatic intervention in the foreign exchange market since Nixon originally floated the US currency.   At the end of February 1985 the dollar reached dizzying heights, which remain a record to this day.  Then it began a long depreciation, encouraged by a shift in policy under the new Treasury Secretary, James Baker, and pushed down by G-5 foreign exchange intervention.  People remember only the September 1985 meeting at the Plaza Hotel in New York City that ratified the policy shift; so celebrations of the 30th anniversary will wait until this coming fall.

The dollar has appreciated sharply over the last year, surpassing its ten-year high.   Some are suggesting it may be time for a new Plaza, to bring the dollar down.   In its on-line “Room for Debate,” the New York Times asked, Will a strong dollar hurt the economy and should the Fed take action?”   Here is my response:

Any movement in the exchange rate has pros and cons.  When the dollar appreciates as much as it has over the last year, the obvious disadvantage is that the loss in competitiveness by US producers hits exports and the trade balance.   But if the dollar had fallen by a similar amount, there would be lamentations over the debasing of the currency!

Overall, the strong dollar is good news.  This is because of the macroeconomic fundamentals behind it.  Indeed textbook theories explain this episode unusually well.  The US economy has performed relatively strongly over the last year — compared to preceding history and to other countries).  This is why the Fed is getting ready to raise interest rates — again, in contrast to the preceding six-year period of monetary easing and also compared to other countries.  (“Divergence.”)   American economic performance and the change in monetary policy are both excellent reasons for the strong dollar.   These developments should be welcomed, taken as a whole, notwithstanding the effect on exports.

Nevertheless, the soaring dollar – especially if it goes much higher – would be a reason for the Fed to hold off past June on its long-anticipated decision to raise short-term interest rates, so as to avoid a growth slowdown or even a descent into deflation.  I believe the Fed would indeed respond in that appropriate way.   In that sense, although the dollar strength is bad for exporters, it will not be bad for output and employment in the economy as a while.

Might a more aggressive intervention to bring down the dollar be justified, in which central banks would get together to sell dollars in exchange for euros and yen?   The last major effort of that sort was the Plaza 30 years ago.  (They also did it in a more minor way, to help the undervalued euro, in 2000.)

But 2015 is not 1985.   Neither the US authorities nor those in other G-7 countries will intervene in the foreign exchange market.  (They agreed not to, two years ago.)  Nor should they, in the current context.   In the first place, the appreciation is not yet anywhere near as big as it was 30 years ago (or even 15 years ago).  In the second place, today’s dollar appreciation is fully justified by economic fundamentals, unlike in 1985.

[The response to the NYT’s question from me and the others can be viewed at Room for Debate: “The Fed and the Dollar.”]

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