14th March 2017
The momentum is growing for rate hikes in the US. Fed speakers, chief amongst them Janet Yellen, have been building the case for some time with the markets now pronouncing a 25 bps move in March as a fait accompli. Supportive of this stance has been recent economic data, which on the face of it at least has remained solid. Solid enough for the Fed to try and make good on their own rate hike projections. Timing is everything when it comes to policy decisions and it may just be the case that the considerable noise coming from the Trump camp offers the perfect cover for a rate hike. Trumpenomics, conspiracy theories, alternative facts etc… are all doing a decent job in keeping the markets distracted for now at least.
Behind all of the headlines, the serious business of running the global economy is proving beyond the capability of the current masters of the world’s reserve currency. Management of the US dollar and its associated impact on global trade is a delicate balancing act. As the reserve currency of the world, the USD plays a fundamental role in the expansion of credit in the system and ultimately the facilitation of global trade. Any reduction in credit availability has the potential to cause havoc as it did most recently in the 2013 taper tantrum. With rate hikes and a continuously low nominal GDP growth (tied with the ending of QE) can we continue to expand credit at a significant enough rate to support the global credit markets? Perhaps an additional cause of apprehension is the fact that the republicans have been asking awkward questions of the Fed recently and their role in providing USD liquidity to fellow central banks. Any potential curtailing of their independence may cause existential ripples around the world’s central banks and markets. It is not a major concern today, but if the US cannot get its mojo back we should be worried given the potential new direction for the Fed under the directorship of the republican party.
The markets need to reflect on the consequences of the last two rate hiking series (1999 and 2004) for the US economy and its capital markets. Are we to believe any policy mishap would not have an equally troubling outcome this time around? The Fed will most likely err on the side of caution as regards tightening, however circumstances may still force their hand with excessive market exuberance (not seen since the dot com bubble) taking hold. Leverage is a dangerous bed fellow and one on which once again we have over-indulged – in many way thanks to the over-enthusiastic actions of global central banks. The markets and risk sentiment indicators such as the VIX tell us there is nothing at all to worry about: not rate hikes or subsiding QE around the world. Nor indeed Trumps’ protectionist plans or the eventual disorderly exit of the UK from Europe. Ironically the time when markets become this complacent is the time we should worry most.
Steve O’Hanlon, February 2017
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