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xysoom
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| Posted: 27 May 2020 at 10:30 | IP Logged
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The market believes the Fed will cut rates by September
¡¡¡¡The federal reserve is changing direction. In
December it predicted that it would raise the federal
funds rate twice in 2019, to 2.75-3.0%. In March it
thought it would hold rates steady instead. Investors now
think there is a one-in-five chance that it will cut
rates at its meeting on June 19th, and a 95% chance that
it will do so by September (see chart). Jerome Powell,
the Feds chairman, has said it is ¡°ready to act¡±.To get
more news about
WikiFX, you can visit
WikiFX news official website.
The reason for the change is a darkening world economy,
caused primarily by the failure of America and China to
strike a deal to bring their trade war to an end. Yet for
all the ructions, the visible impact on Americas hard
economic data has so far been relatively small. True,
American firms hired only 75,000 workers in May, on first
estimate, well below the recent monthly average. But jobs
data are volatile, and the unemployment rate is a very
low 3.6%.
¡¡¡¡Where the pain of the trade war has shown up is
mainly in financial markets. The ten-year Treasury yield,
for instance, was 2.5% in early May but has since fallen
to 2.1% as investors have rushed to safety and
anticipated rate cuts. Large moves like these raise an
uncomfortable question for the Fed. Should it yield to
the market, thereby risking the appearance that monetary
policy is set by traders£¿ Or should it consider only
backward-looking economic data, which move slowly£¿
¡¡¡¡Markets provide the aggregated wisdom of a crowd of
individuals with money on the line. In most contexts
their forecasts will outperform those of a financially
disinterested committee, even one made up of experts. But
there are other reasons why an apparent discrepancy
between the two may endure.
¡¡¡¡The first is that there is not really a discrepancy
at all. Suppose the Fed and the market make the same
judgment about the risk of an economic shock such as a
trade war. ¡°The Fed has the luxury of more time,¡± says
Torsten Slok, an economist at Deutsche Bank. It can wait
to see what happens before changing policy, whereas
investors must hedge their bets immediately to account
for even unlikely events.
¡¡¡¡The second is that markets agree with the central
bank about the economic outlook, but are confused about
how it will act. ¡°The Fed might have failed to
communicate well,¡± says Frederic Mishkin, a former rate-
setter.
¡¡¡¡Only if these possibilities can be ruled out can
central bankers conclude that markets are telling them
something they need to hear about growth and inflation.
Discerning this signal becomes trickier the more the Fed
appears to respond to the market. To see why, suppose
that the Fed ignores market movements completely, and
instead sets policy in an entirely predictable way,
responding only to hard data on growth and inflation. Any
change in market expectations about Fed policy would then
reflect only changes in investors perception of the
outlook for those variables. ¡°If Fed policy is clear and
systematic,¡± says Charles Calomiris of Columbia
University, ¡°policymakers can glean useful information
from markets.¡± The more the Fed responds to the market,
however, the more it is ¡°looking in the mirror¡±, as
Alan Greenspan, a former Fed chairman, supposedly once
quipped.
¡¡¡¡If monetary policy were entirely automated, however,
the information embodied in markets would be useful but
unused. What is more, reacting only to real data is like
driving while looking only in the rear-view mirror.
Central bankers often say that monetary policy works only
with a lag of 18 months or two years. Many economists
believe that flat-footedness at the Fed has been to blame
for numerous post-war American recessions.
¡¡¡¡If the Fed wants to glean useful information from
markets, it cannot pander to them. ¡°The Fed needs to be
the dog that wags the tail,¡± says Mr Mishkin. But when
market movements have a fairly clear cause¡ªin todays
case, the trade war¡ªand the reaction is severe, it is
likely that a rate cut will eventually be necessary. The
short-term risk of moving in anticipation of events is
that the outlook brightens and the rate cut then sparks
inflation. Yet to the extent that economic data are
telling a clear story, it is that inflation is contained.
Consumer-price inflation, for example, slowed to 1.8% in
May. That suggests it would be better for the Fed to get
on with the rate cuts that the market expects.
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Topic: The market believes the Fed will cut rate
