Date: July 18, 2018
Powell Wants to Create Some Mystery Around Fed Meetings
Change is in the air at the Federal Reserve. Chairman Jerome Powell’s semiannual monetary policy testimony in the Senate gave a big hint that we can no longer count on the explicit policy of gradual interest-rate hikes to continue too much longer. That doesn’t mean gradual rate increases will end, only that the Fed will rely less on forward guidance. A slower or faster pace of hikes, an extended pause, or even a rate cut are all possibilities at this point. In his testimony Tuesday, Powell added the qualifier “for now” as he reiterated the Fed’s commitment to the current policy of gradual rate increases. This addition signals that the Fed is preparing for a shift in their policy guidance. Why prepare for a shift? Policy rates will soon approach the central tendency range of what policy makers estimate to be neutral, currently 2.8 percent to 3.0 percent. But that range is just an estimate. The true neutral rate is unobservable. Hence, as rates approach that range, policy makers need to more carefully assess the current and expected state of the economy before blindly pushing rates higher. They could afford to be on autopilot when rates were far from neutral; they will soon no longer have that luxury. My view is that the next two rates hikes are looking like a near certainty at this point. The economy exhibits too little inflation to consider accelerating the pace of rate hikes with an August hike and retains too much momentum for the Fed to consider pausing at the September meeting. Moreover, I doubt this calculus will change by fourth quarter, meaning a hike in December but not October. By 2019, however, the guidance will shift away from an implicit expectation of a 25-basis-point boost each quarter. Officials will increasingly emphasize the role of incoming data when setting policy. In his testimony, Powell provided a clue on what to look for when sifting through the data. He noted that recent job growth is “a good deal higher than the average number of people who enter the work force each month on net.” I don’t think the Fed will believe they have reached a neutral rate until this is no longer the case.
Euro-Area Core Inflation Revised Lower as ECB Moves on With Exit
The latest update on inflation bears a warning for the European Central Bank. Prices excluding volatile components rose less than initially reported in June, the month policy makers announced that net asset purchases would end this year. The core rate fell to a two-month low of 0.9 percent, compared to an earlier estimate of 1 percent and a reading of 1.1 percent in May, according to a Eurostat report. Headline inflation was confirmed at 2 percent. The ECB aims to keep price growth just below that rate in the medium term. Increased confidence in the inflation outlook was the main reason policy makers cited for their decision to slowly unwind unprecedented stimulus. Based on updated forecasts, ECB President Mario Draghi said at the time that record-low interest rates and large-scale asset purchases had contributed to a substantial improvement in the outlook, predicting that underlying price growth would pick up toward the end of the year. The revision is a slight setback for the ECB and underlines the need for caution in scaling back accommodation. Executive Board member Peter Praet has stressed in recent speeches that “significant” stimulus is still needed to further build up domestic price pressures.
How Strong Is China’s Economy? GDP Alone Won’t Say
It’s the go-to measure of an economy. But sometimes gross domestic product doesn’t tell you much. A glance at China’s second-quarter GDP, released Monday, might suggest things are holding up pretty well in the world’s second-largest economy. The 6.7 percent increase from a year ago — just barely below the prior period — points to a China that weathered the early skirmishes of a trade war, continued its transition to a consumption-driven economy and isn’t suffering too much from a state campaign to rein in debt. Fair enough, as far as it goes. But the quarterly data doesn’t convey that activity slowed significantly in June, the last month of the period under review. (This isn’t a comment on whether China’s figures are cooked, though there are skeptics who point to comments WikiLeaks attributed to premier Li Keqiang when he was a provincial leader that GDP is “manmade” and “for reference only.”) Figures released the same day as GDP showed fixed-asset investment by the government and state-owned enterprises grew at the slowest pace since at least 2004 last month, and industrial production cooled. Two other numbers showed a mixed bag: Retail sales were healthy, while a report Friday showed new loans by the shadow-banking system dropped the most on record. Similarly, the quarterly headline also gives the impression that Beijing’s campaign to rein in debt isn’t denting the broader economy and that little course correction is warranted. In reality, China is tweaking monetary policy to prevent June’s softness leading to a more pronounced slackening. The imposition of tariffs by President Donald Trump (and China’s retaliation) gives the task more impetus. The People’s Bank of China has trimmed the amount of cash that banks are required to hold as reserves, albeit with very specific conditions. The PBOC demurred on interest rates in June instead of following the Federal Reserve’s hike, as some economists had anticipated. Government spending picked up in June, focused on environmental protection, science and technology. These steps don’t amount to a wholesale opening of the spigot; they do show that President Xi Jinping’s team is attuned to risks and is prepared to take further steps, preferably without compromising debt reduction. Soft landings are tricky.
India Poised to Infuse $2 Billion Into State-Run Banks
India will inject at least 135 billion rupees ($2 billion) into state-controlled banks this month, as it seeks to shore up capital buffers and help the lenders meet coupon payments on their bonds, people familiar with the matter said. The new capital infusion will ensure the state banks have room to grow their loan books while meeting capital requirements, the people said, asking not to be named as the information isn’t public. It’s the latest step in Prime Minister Narendra Modi’s 2017 plan to add 2.11 trillion rupees of capital into the lenders over two years, the people added. The government has been forced to inject capital because worries about bad debt and poor profitability has made it difficult for Indian banks to raise money on their own. The scope of state-controlled banks to sell shares has also been curtailed by a rule that requires the government to own at least 51 percent of the lenders. Punjab National Bank, which has been short of capital after being hit by a record $2 billion fraud, gets the single largest capital allocation at 28 billion rupees, the people said.