Are the Fed’s interest rate projections credible?

At the FOMC meeting on September 19 and 20, members charted the central bank’s so-called dot plot of expected rates for the years out to 2020, involving one interest rate hike in 2017, three in 2018, two in 2019 and only one in 2020, leading to an end figure of 2.875% vs. 1.125% currently. These figures published by the Fed are generally extreme, as the US central bank endeavors to influence investors’ expectations to suit its own narrative. Continue reading

The Fed normalizes its monetary policy but is not optimistic

As expected, the Federal Reserve has decided to start the process of reducing the size of its balance sheet. It will start next month in October. Details of the operation were presented in June and are available on a post send earlier today.

During her press conference, Janet Yellen has clearly announced the hierarchy between the two instruments the Fed can use to manage its monetary policy. The main instrument remains the fed fund interest rate. In “normal” time, this is the instrument that must be used by the FOMC to manage its monetary policy. The purchases of assets could become again an instrument for the Fed if the situation is exceptional. The interest rate is the rule and the assets’ purchase is the exception. But it was a relevant question as the current level of the fed fund is too low to have a strong impact on the economic activity in the case of a negative shock. A quantitative adjustment could be necessary. Janet Yellen sees a kind of complementarity between the two and the two instruments must remain in the central banker toolbox.  Continue reading

The US Federal Reserve in unknown territory

Written with Aline Goupil-Raguénès

During today’s meeting, the probability is high that the Federal Reserve will decide to reduce the size of its balance sheet.
This latter started to increase at the end of 2008, first when the Fed was a provider of liquidity to the banking sector, and second when the US central bank started to purchase assets on a large scale. Few figures will give the scale of the transformation; in 2007 on average the size of the balance sheet was USD 830bn, it is now close to USD 4 500bn. As percentage of GDP the change is impressive from 5.7% on average in 2007 to 23% during the second quarter of this year.
Many questions are associated with this new step in the normalization of the US monetary policy. That’s the reason of this post and of the attached detailed document which is more technical but also more precise on the way it will work. Continue reading

Fed: The announced normalization

The Fed main interest rate was increased by 25bp at the June meeting of the FOMC. It will now be in the corridor [1; 1.25%]. This is the fourth hike since December 2015 (start of the tightening cycle).
The impact of this monetary policy change has been very limited. The Fed’s communication strategy is to clearly say in advance what it will do. The Fed doesn’t want to create surprises to investors. Therefore investors can adapt their expectations and their portfolios to the new monetary policy stance. The impact of the measure when it is announced is null.
This is interesting notably on emerging markets. In the past, the Fed’s tightening cycle had a strong impact on them as capital flows were back to the US at the expense of emerging countries. Investors were surprised by the Fed’s move. That’s what economists call a sudden stop. Here, no one is surprised so there are no reversal in flows and emerging markets remain strong.

The Fed considers that the economy is now close to full employment (employment rate is 4.3%) and the inflation is close to its 2% target. Therefore it can be rational to increase rates. But as mentioned earlier, the Fed doesn’t want to create too much volatility and to create a persistent shock on the economy. That’s why its measures are announced loudly in advance.  Continue reading

Paris Accord and Fairness for the US

Is the Paris accord on Climate so unfair for the United States? Donald Trump said it was the main reason to exit from it.
Using three different measures Professor Peter Singer shows that the Paris accord was not disadvantageous for the US.
To take just the first of them, Singer says that the US population is 5% of the world population but the gas emission by the US is 15% of the total. It means that current US emissions should be one-third of what they are. Obama commitment was just 27% below 2005 level in 20125. Is it unfair?

Read the article here