Date: July 25, 2018
Trump Wants the Fed to Roll Back the U.S. Economy
Doves on the Federal Reserve evidently have a vocal ally in President Donald Trump. He said recently that he’s “not thrilled” about the Fed increasing interest rates – a move the central bank is expected to signal this week, without yet doing so. The president’s concern comes at the same time that interest rate watchers are getting nervous about how rapidly the yield curve is flattening, with the rates on 2-year and 10-year notes continuing to converge. While it seems likely for now that the Fed will continue to increase interest rates at least until back to the Fed’s estimation of “neutral” or the yield curve inverts, a pause at that level has the potential to signify the Fed has finally gotten past the era of high interest rates, a precedent set in the 1970s. Doing so would help reorient the economy in the direction in which Trump hopes to move it. Pausing, perhaps ending, interest rate hikes over the next several months would represent a sea change not just for monetary policy, but also for the makeup of the U.S. economy as it’s been since the early 1980s. Following the trauma of high inflation in the late 1970s, the Federal Reserve, first under Chairman Paul Volcker and continued by his successor, has been obsessed with maintaining the credibility of the U.S. central bank as an inflation fighter. The Fed has shown it’s been successful at holding inflation at bay, but that has come at a cost. One of the main ways the Fed has won its credibility on inflation has been setting interest rates higher, sometimes much higher, than the inflation rate. This was most extreme in 1984, when short-term interest rates spent much of the year over 10 percent while consumer price inflation (stripping out food and energy) finished the year under 5 percent. When investors and savers can get a “free lunch” by earning a high inflation-adjusted return in Treasuries, they’re incentivized to do so rather than invest in new production or consuming goods and services, both of which would put upward pressure on inflation. But this has broader distortionary effects in the economy. On a global level, if investors can earn a high real interest rate on U.S. assets, they’re going to do so, which all else equal will drive the dollar higher in foreign exchange markets than it otherwise would be. The dollar being artificially higher will make U.S. exports less competitive in global markets, leading to larger trade deficits.
Brexit Turmoil Ignites Trading Boom in World’s Biggest FX Hubs
Brexit turmoil is fueling a surge in currency trading in the world’s biggest foreign-exchange centers. Turnover in the U.K. rose to a record $2.73 trillion a day in April, according to data from the Bank of England’s Foreign-Exchange Joint Standing Committee. That’s up 14 percent from a year earlier, and exceeds the previous record from October 2014. In North America, market activity rose to $994 billion, 12 percent higher than a year earlier, a report from the Federal Reserve Bank of New York showed. In both regions, the British pound-U.S. dollar currency pair accounted for the biggest jump in volumes. “It’s not a big surprise given the flip-flopping we’ve had on BOE and Brexit politics,” said Kenneth Broux, a strategist at Societe Generale SA. “For the pound, you have forces constantly pulling in different directions — the BOE swerve and dithering on Brexit.” Sterling-dollar trading jumped to a record $351 billion a day in April in the U.K., up 19 percent from a year earlier, the BOE data showed. Banks including UBS Group AG have benefited from wider market volatility, with the Swiss lender’s revenue from foreign-exchange and fixed-income products rising 35 percent from a year ago in results released Tuesday. The surge in trading of the British currency has been spurred by investors turning more optimistic given “the relatively positive evolution of the U.K. economy and the agreement between the U.K. and the EU regarding the transition period after Brexit,” said Roberto Cobo Garcia, head of Group-of-10 currency strategy at Banco Bilbao Vizcaya Argentaria SA. Since April, however, the market has turned more bearish on sterling, with the March 2019 Brexit approaching and investors growing increasingly worried about the prospect of no deal with the European Union. The pound has weakened about 6 percent over the past three months as uncertainty created by Brexit negotiations muddies the outlook for the BOE’s withdrawal of monetary stimulus. “Our traders still think that we could see higher volumes and that the market is still not as liquid as it should be given the monetary policies of the past few years,” Cobo Garcia said.
Swelling Deficits Are Southeast Asia’s Next Stability Test
Southeast Asian governments are staring down swelling budget deficits in the latest test for regional stability. As higher U.S. interest rates and a stronger dollar roil currencies in the region and oil prices spike, governments from the Philippines to Malaysia are facing rising debt. A less rosy growth picture also means tax revenues may come in below targets, threatening budget goals. The result is more borrowing at a time when interest rates are rising, putting additional strain on government finances. Many governments were already spending billions of dollars on much-needed rail and road projects before the market turmoil, and some, like Indonesia, are now scaling back those plans to keep deficits in check. Here are the Southeast Asian nations with the biggest budget dilemmas: Malaysia: Budget deficit, 2018 target: 2.8% of GDP Moody’s estimate: 2.7%. Malaysia’s two-month-old government has credit agencies guessing on how much the balance sheets will be turned upside-down. Prime Minister Mahathir Mohamad has already delivered on some campaign promises that strain the government budget, scrapping a 6 percent goods-and-services tax and re-instituting fuel subsidies. His administration has promised to offset the lost revenue with a new sales tax and cancellation of some big infrastructure projects, but it’s yet unclear how much those initiatives will help even out the ledger. Mahathir’s focus is on bringing down debt, which Moody’s Investors Service estimates is at 50.8 percent of gross domestic product, higher than other A-rated peers. a net energy exporter, higher oil prices are a boon for Malaysia, which will help offset some of the pressure on government revenues. Indonesia: Budget deficit, 2018 target: 2.19% of GDP, Moody’s estimate: 2.4%. To stabilize the currency and curb the current-account gap, the government is scaling back on some of its large-scale infrastructure projects that require imported capital equipment. One area of increased spending: energy subsidies doled out to consumers to keep a lid on fuel prices. Finance Minister Sri Mulyani Indrawati says the move shouldn’t hurt the deficit because as an oil producer, higher crude prices would provide some cushion. She sees the deficit at 2.12 percent of GDP this year, lower than the 2.19 percent forecast in the annual budget. Philippines:Budget deficit, 2018 target: 3% of GDP Moody’s estimate: 3%. President Rodrigo Duterte’s “Build, Build, Build” program is producing too many bills, bills, bills, by some analysts’ estimates. While the ambitious infrastructure plan is much-needed to upgrade airports, roads and railways, it’s also hurt the current account and put pressure on the budget. The proposed borrowing plan for next year is 19 percent higher than this year’s program. The government has raised its budget deficit target for next year to 3.2 percent of GDP from an estimated 3 percent this year in order to accommodate the infrastructure push. The deficit worries were a factor in failed government bond sales over the past month, while also weighing on the peso. The currency is among the worst performers in Asia, down 6.6 percent against the dollar this year.