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22 Dec 2015
Monetary policy normalization to be a function of Fed expectations and economic data - BBH
FXStreet (Delhi) – Marc Chandler, SVP at BBH, suggests that the pace that monetary policy can be normalized will be a function of the economic data in absolute terms and Fed expectations.
Key Quotes
“At the same time, the broad financial conditions, which include the dollar’s exchange rate and financial markets, will also be taken into account. We expect the pace of job growth to be moderate, but without a marked increase in the participation rate, it may still be sufficient to absorb slack in the labor market. This means unemployment (and underemployment) will likely decline. The fall in energy prices may help check headline inflation. Core measures are likely to increase on the back of higher rents and medical services.”
“Presidential election years without an incumbent running have tended to be associated with a small decline in equity prices. We do not see the election as having had much impact on the trajectory of Fed policy. At most, the Fed may want to avoid action at the November 2, 2016 FOMC meeting, which does not include updated economic forecasts, nor is it followed by a press conference.”
“There are several factors that make this cycle unique and arguably, even more challenging than would normally be the case. Lower nominal GDP means that interest rates will be below levels that prevailed in previous cycles. The Fed has new tools, like interest on excess reserves and scaled-up reverse repos that have not been battle-tested.”
“Unlike past cycles, the Fed has set a target range for Fed funds rather than a fixed point target. It is not clear where Fed funds will trade relative to its range. We have argued that to maximize the effectiveness of its new tools, the Fed may want to provide sufficient liquidity to keep the effective Fed funds rate (weighted average) somewhat below the mid-point of the range. That would also help officials drive home the point of gradual increases.”
“The Fed’s balance sheet is also in play in a way it was not in past cycles. An estimated $220 bln of US Treasuries the Fed owns may mature in 2016. It cannot be expected to allow the full amount to roll-off, but maybe around mid-year, the Fed may begin exploring this tool. Letting some fraction mature and/or refrain from reinvesting interest payments would be seen as providing a tightening impulse.”
Key Quotes
“At the same time, the broad financial conditions, which include the dollar’s exchange rate and financial markets, will also be taken into account. We expect the pace of job growth to be moderate, but without a marked increase in the participation rate, it may still be sufficient to absorb slack in the labor market. This means unemployment (and underemployment) will likely decline. The fall in energy prices may help check headline inflation. Core measures are likely to increase on the back of higher rents and medical services.”
“Presidential election years without an incumbent running have tended to be associated with a small decline in equity prices. We do not see the election as having had much impact on the trajectory of Fed policy. At most, the Fed may want to avoid action at the November 2, 2016 FOMC meeting, which does not include updated economic forecasts, nor is it followed by a press conference.”
“There are several factors that make this cycle unique and arguably, even more challenging than would normally be the case. Lower nominal GDP means that interest rates will be below levels that prevailed in previous cycles. The Fed has new tools, like interest on excess reserves and scaled-up reverse repos that have not been battle-tested.”
“Unlike past cycles, the Fed has set a target range for Fed funds rather than a fixed point target. It is not clear where Fed funds will trade relative to its range. We have argued that to maximize the effectiveness of its new tools, the Fed may want to provide sufficient liquidity to keep the effective Fed funds rate (weighted average) somewhat below the mid-point of the range. That would also help officials drive home the point of gradual increases.”
“The Fed’s balance sheet is also in play in a way it was not in past cycles. An estimated $220 bln of US Treasuries the Fed owns may mature in 2016. It cannot be expected to allow the full amount to roll-off, but maybe around mid-year, the Fed may begin exploring this tool. Letting some fraction mature and/or refrain from reinvesting interest payments would be seen as providing a tightening impulse.”