Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
Dow Short-term Trend Analysis - Coronavirus Trigger a Stocks Bear Market? - 24th Feb 20
Sustained Silver Rally Coming? - 24th Feb 20
Should Investors Worry about Repo Market and Buy Gold? - 24th Feb 20
Are FANG Technology Stocks Setting Up For A Market Crash? - 24th Feb 20
Gold Above $1,600 Amid FOMC Minutes and Coronavirus Impact - 24th Feb 20
CoronaVirus Pandemic Day 76 Trend Forecast Update - Infected 540k, Minus China 1715, Deaths 4920 - 23rd Feb 20 -
Ways to Find Startup Capital - 23rd Feb 20
Stock Market Deviation from Overall Outlook for 2020 - 22nd Feb 20
The Shanghai Composite and Coronavirus: A Revealing Perspective - 22nd Feb 20
Baltic Dry, Copper, Oil, Tech and China Continue Call for Stock Market Crash Soon - 22nd Feb 20
Gold Warning – This is Not a Buying Opportunity - 22nd Feb 20
Is The Technology Sector FANG Stocks Setting Up For A Market Crash? - 22nd Feb 20
Coronavirus China Infection Statistics Analysis, Probability Forecasts 1/2 Million Infected - 21st Feb 20
Is Crude Oil Firmly on the Upswing Now? - 20th Feb 20
What Can Stop the Stocks Bull – Or At Least, Make It Pause? - 20th Feb 20
Trump and Economic News That Drive Gold, Not Just Coronavirus - 20th Feb 20
Coronavirus COVID19 UK Infection Prevention, Boosting Immune Systems, Birmingham, Sheffield - 20th Feb 20
Silver’s Valuable Insights Into the Upcoming PMs Rally - 20th Feb 20
Coronavirus Coming Storm Act Now to Protect Yourselves and Family to Survive COVID-19 Pandemic - 19th Feb 20
Future Silver Prices Will Shock People, and They’ll Kick Themselves for Not Buying Under $20… - 19th Feb 20
What Alexis Kennedy Learned from Launching Cultist Simulator - 19th Feb 20
Stock Market Potential Short-term top - 18th Feb 20
Coronavirus Fourth Turning - No One Gets Out Of Here Alive! - 18th Feb 20
The Stocks Hit Worst From the Coronavirus - 18th Feb 20
Tips on Pest Control: How to Prevent Pests and Rodents - 18th Feb 20
Buying a Custom Built Gaming PC From Overclockers.co.uk - 1. Delivery and Unboxing - 17th Feb 20
BAIDU (BIDU) Illustrates Why You Should NOT Invest in Chinese Stocks - 17th Feb 20
Financial Markets News Report: February 17, 2020 - February 21, 2020 - 17th Feb 20
NVIDIA (NVDA) GPU King For AI Mega-trend Tech Stocks Investing 2020 - 17th Feb 20
Stock Market Bubble - No One Gets Out Of Here Alive! - 17th Feb 20
British Pound GBP Trend Forecast 2020 - 16th Feb 20
SAMSUNG AI Mega-trend Tech Stocks Investing 2020 - 16th Feb 20
Ignore the Polls, the Markets Have Already Told You Who Wins in 2020 - 16th Feb 20
UK Coronavirus COVID-19 Pandemic WARNING! Sheffield, Manchester, Birmingham Outbreaks Probable - 16th Feb 20
iShares Nasdaq Biotechnology ETF IBB AI Mega-trend Tech Stocks Investing 2020 - 15th Feb 20
Gold Stocks Still Stalled - 15th Feb 20
Is The Technology Stocks Sector Setting Up For A Crash? - 15th Feb 20
UK Calm Before Corona Virus Storm - Infections Forecast into End March 2020 - 15th Feb 20

Market Oracle FREE Newsletter

Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

From the Era of Fed Interest Rates Easing to the Era of Tightening

Interest-Rates / US Interest Rates Jun 05, 2017 - 01:12 PM GMT

By: Dan_Steinbock

Interest-Rates After half a decade of ultra-low rates in the United States, the Fed is hiking rates and moving ahead to reduce its massive $4.5 trillion balance sheet. The consequences will reverberate across the world, including Asia.

Before the Trump era, the Federal Reserve hoped to tighten monetary policy more often and aggressively than markets anticipated. But since November, US economic prospects have fluctuated dramatically, from the Trump trade to new volatility.


In its May meeting, the Fed left its target range for federal funds rate steady at 0.75-1 percent, in line with market expectations. It is likely to climb to 1.3 percent by the year-end and to exceed 3 percent by 2020.

In other major advanced economies, monetary stance has remained broadly unchanged. The European Central Bank (ECB), led by Mario Draghi, held its benchmark rate at 0 percent in April. While the ECB has signaled impending normalization, it will continue its asset purchases until the year-end. Even if the ECB begins rate hikes in 2018, they are likely to be low and slow. The rate could climb to 1 percent by 2020.

In Japan, Abenomics has failed, despite slight improvement in short-term growth prospects. As introduced by Haruhiko Kuroda, the chief of the Bank of Japan (BOJ), negative rates and huge asset purchases will continue. The rate may remain negative (-0.1%) until 2020 – by then Japan’s sovereign debt will exceed 260 percent of its GDP.

Yet, rate normalization is only a part of the story. After the Fed began its historical experiment with quantitative easing (QE), its then-chief Ben Bernanke accumulated a portfolio of some $4.5 trillion. Now the question is how his successor Janet Yellen plans to reduce it.

Adding to uncertainty is the fact that she is likely to be replaced at the end of her term in 2018 with a Republican whose views of US economy and markets are more in line with those of the Trump administration.

Subdued balance-sheet contraction

Since 2008, I have argued that, despite its hawkish rhetoric, the Fed will not be able to increase rates as early, as often and as much as it initially hoped. And nor will the Fed reduce its balance sheet as early, as often and as much as it initially signaled. Though widely different from the consensus half a decade ago, it seems now that both forecasts have been to the point. The Fed’s current objective seems to be to hike rates up to only 3 percent.

Theoretically, the Fed has a half a dozen options to reduce its balance sheet, according to its minutes. In practice, it will opt for one of three scenarios. It can sell some assets at once or over time. It can halt the reinvestment of maturing assets. Or it will taper the reinvestment of maturing assets. The latter is the most likely option since the Fed has officially announced its intention to deploy interest rate as its main instrument (which requires gradual shrinking of the balance sheet).

The Fed’s objective is not to fully unwind its balance sheet. Rather, it may reduce its balance sheet by about $2 trillion in some 4-5 years, according to its minutes. Concurrently, the role of the remaining $2.5 trillion could probably be legitimized as a “new policy instrument,” which would be deployed as a cushion amid future crises.

Prior to the global crisis and the QE rounds in major advanced economies, there was little understanding about the probable impact of balance sheet expansion on monetary conditions. Bernanke deemed such measures necessary, but critics saw them as neither effective nor harmless but as harbingers of an “inflation-holocaust.”

Today, the understanding of the impact of balance sheet contraction on monetary conditions remains equally deficient. Consequently, critics are likely to portray Yellen's QT measures as ineffective, adverse, or harbingers of an impending “deflation-holocaust.”

What seems certain is that, as the Fed plans to continue increasing rates, even as it is reducing its balance sheet, both activities will translate to tightening monetary conditions – not just in the US but around the world.

Unfortunately, the track record of the Fed’s tightening is dark – even without balance-sheet reductions.

Reversal of 'hot money' flows?

In the early 1980s, Fed chief Paul Volcker resorted to harsh tightening that devastated US households, while leading to a "lost decade” in Latin America. Subsequently, Alan Greenspan’s rate hikes brought down struggling savings and loans associations, forcing Washington and states to bail out insolvent institutions.

In the early 1990s, Greenspan again seized tightening but then reversed his decision, which undermined expansion. In the first case, global growth decelerated to less than 1 percent; in the second, it plunged to 4 percent below zero in developing nations. In 2004-7, the rate hikes by Greenspan and his successor Ben Bernanke contributed to the global financial crisis. In low-income economies, growth stayed at 5-7 percent thanks to China's contribution to global growth.

During the QE era, after traditional monetary policies had been exhausted, the central banks of advanced economies effectively created what I termed the "hot money" trap, thanks to short-term portfolio flows into high-yield emerging markets. As a result, the latter had to cope with asset bubbles, elevated inflation and exchange rate appreciation. That’s when Brazil’s Minister of Finance Guido Mantega first warned about “currency wars,” while China’s Minister of Commerce Chen Deming complained the mainland was being attacked by “imported inflation.”

Assuming a reverse symmetry, the impending US hikes have potential to attract "hot money" outflows from emerging economies leaving fragile countries struggling with asset shrinkages, deflation and depreciation. In that scenario, the “hot money” trap of the early 2010s would be replaced by the “cold money” trap in the late 2010s.

On the one hand, today emerging economies are stronger and better prepared to cope with tightening. On the other hand, global growth is no longer fueled by major advanced economies as in the 1980s and 1990s, but by large emerging economies, which must cope with their adverse impact – which, in turn, has potential to penalize global growth prospects.

In 2013, when Bernanke announced the Fed would no longer purchase bonds, the statement caused a mass global panic. Today, the central banks of major advanced economies are navigating into new, unknown and dangerous waters. If, in the past, over-ambitious or misguided tightening caused “lost decades,” today the net effect could be far worse.

The brief “taper tantrum” in 2013 was one thing. Multi-year rate hikes, coupled with balance-sheet reductions, in major economies that are highly indebted, suffer from aging demographics and are coping with secular stagnation – well, that’s a different story altogether.

Dr. Dan Steinbock is an internationally recognised expert of the nascent multipolar world. He is the CEO of Difference Group and has served as Research Director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Centre (Singapore). For more, see www.differencegroup.net   

© 2017 Copyright Dan Steinbock - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules