If you read today’s US print edition you would determine that the US Fed is in a right pickle. Domestic data would suggest the US economy is making progress and there are arguments for raising rates. However international data suggests there is great risk. Even in the last 24 hours, we have seen the World Bank suggest raising rates will damage emerging market (EM) growth significantly; today’s paper includes reports from Asia where EM central bankers are calling for the rate rise. What to do?
The Comment piece by Richard Fisher, former president of the Federal Reserve Bank of Dallas, is apersuasive narrative (see Monetary policy operates with a time lag so the Fed must act soon) on the real underlaying inflation “gap”that has plagued public and official reporting of that troublesome data point. Low and persistently low inflation is one of the key measures the US Fed has said would hold back a rate rise. The other troublesome indicator is wage growth. But Fisher suggests that there are more modern models for inflation that show the real rate is closer to the 2% the US Fed is looking for. I myself have blogged in the past (see US Inflation analytic is out of data. So Let’s Update it Then!) that real inflation, what consumers see in the shops and at home, has been creeping up all along.
However in Emerging Markets Braced for Rippler Effect, Mohamed El-Erian, chief economic advisor to Allianz, pointed out the connected nature of our global economy. As US interest rates rise, so investing in the US will look more attractive than, say, investing in China. At the margins capital will shift from China to the US. Only last week China had to use some of its vast FX and US treasury reserve to defend the yuan. Should capital flow from China, the value of its currency will fall, and so the Chinese authorities may need to defend the yaun again. If China continued selling some of its US treasuries, this could create a glut of debt instruments on offer by the US. To help encourage the picking up of that glut, the US will be pressured to increase rates further. Thus this very first small rate rise that the US Fed is contemplating has to be right; and it could create a domino effect that will be hard to stop.
So all in all the data provides mixed messages, both domestically as well as internationally. And worse, the actual delay itself as to when the rates will actually rise is adding to market volatility. As I said the other day, the US Fed is dammned if they don’t increase rates, and dammned if they do. The problem is, not knowing which damnation awaits, is itself a horrible situation to be in. Oh to be paid the big bucks and lead the Federal Reserve.