June 1, 2018
Fed’s Brainard Says Gradual Rate Hikes Remain ‘Appropriate Path’
A strong fiscal boost to the U.S. economy at a time of low unemployment suggests a gradual pace of interest-rate increases remains “the appropriate path” to prevent growth from overheating, Federal Reserve Governor Lael Brainard said. “Continued gradual increases in the federal funds rate are likely to be consistent with sustaining strong labor market conditions and inflation around target,” Brainard said Thursday in a speech to the Forecasters Club of New York. “This outlook suggests a policy path that moves gradually from modestly accommodative today to neutral — and, after some time, modestly beyond neutral.” That last line is important because for central bankers, the neutral rate is the level that’s neither adding stimulus nor restraining the economy. Going past neutral means her outlook includes monetary policy that gets a little restrictive. Her remarks were also notable for how optimistic she remains in the face of market turmoil in Europe and a brewing trade war involving some of the world’s largest economies. Brainard’s speech validates investor expectations that the central bank will raise the benchmark lending rate when officials next meet June 12-13, and her outlook appears similar to the policy path published by the Federal Open Market Committee in March. At that time, central bankers forecast the federal funds rate that keeps supply and demand in balance in the economy over the longer run at 2.9 percent. They forecast the rate would be 3.4 percent at the end of 2020. “It seems likely that the neutral rate could rise in the medium term above its longer-run value,” said Brainard, who was appointed by President Barack Obama to the central bank’s Board of Governors. “I expect current tailwinds to boost the neutral rate gradually over the medium term but leave little imprint on the long-run neutral rate.” The FOMC’s latest forecasts published in March show an even split among policy makers between three and four hikes for 2018, excluding outliers. Bets in financial markets on four rather than three hikes have faded in recent days as financial markets have been roiled by everything from political uncertainty in Italy and Brazil to U.S. trade disputes, conditions Brainard generally described as downside risks worth watching. “Political developments in Italy have reintroduced some risk, and financial conditions in the euro area have worsened somewhat in response,” Brainard said, noting that monetary policies in advanced economies are likely to diverge for some time.
U.K. Economy Risks Being Dragged Down by Shoppers’ Brexit Worry
British consumers are worried about prospects for the economy with Brexit on the horizon, and that could spark a shift in behavior that drags even more on growth. Households have driven expansion for more than a year, but only because they saved less to keep up spending during 2017’s inflation surge. They may be less willing to do so if their concerns about weakening growth — and their job security — stay elevated. According to a monthly index from GfK, a measure of expectations is below the 20-year average and consumers “remain resolutely downbeat about the general state of the economy.” A weaker property market, as seen in the latest Nationwide house-price report, could compound fears. Mortgage approvals declined in April, the Bank of England reported on Thursday. Consumer borrowing, by contrast, rebounded last month to the highest since 2016, suggesting consumers haven’t yet committed to reining in spending. Dan Hanson, an economist at Bloomberg Economics, says saving is far below a sustainable level, creating a risk of retrenchment. One trigger could be Brexit. The U.K.’s official exit from the European Union is less than a year away and if the country leaves without a formal deal in place, that could dent confidence. “The saving rate has fallen off a cliff as consumers carried on spending in reply to a living standards squeeze last year. That stubbornness has left the U.K.’s biggest spenders in a precarious position, with little buffer to weather any shocks.” That means a shock would prompt consumers to save more, which means spending gets cut back and a key support for economic growth disappears. That would be a further blow to Britain’s high-street retailers, already under pressure, and also the broader economy. Bloomberg Economics estimates that the U.K. could even “flirt with recession.”
Italy Bonds Gain as Populists Take Power But Skepticism Lingers
Italian bonds climbed for the third day, extending a relief rally after the nation’s two populist parties agreed to form a government. Two-year securities led gains across the curve as the Five Star Movement and the League managed to piece together a team after their original pick for finance minister was vetoed. Giuseppe Conte, 53, a law professor with no political experience, will be sworn in as prime minister along with his cabinet later Friday. The new government is still seen as risky for long positions in Italian debt given dangers of credit downgrades and capital outflows, according to Societe Generale SA, which recommends using the rebound to add short positions. Analysts at ING Groep NV suggest markets will likely remain skeptical about the coalition’s commitment to the European Union. “There’s a bit of ‘once bitten, twice shy’ in Italian bonds,” said Richard Kelly, head of global strategy at Toronto-Dominion Bank in London. “You’ll still see nervousness likely keep spreads and yields from falling back to where we started, but a lack of bad news for a while should let some compression continue for now.” Italian two-year rates fell 30 basis points to 0.76 percent, while 10-year ones dropped 17 basis points to 2.63 percent. The spread on the longer-dated note over German bunds narrowed by 20 basis points to 225. In May, Italy’s benchmark debt had the biggest monthly loss since records began as the political upheaval in Rome called the future of the euro into question. Spreads between Italian and German bond yields surged beyond 300 basis points on Tuesday, the widest since 2013. While they have now retreated, analysts remain skeptical on what a populist government will mean for fiscal spending and the nation’s euro membership. Despite the stunning losses this week, Pacific Investment Management Co’s chief investment officer for global fixed income Andrew Balls told Bloomberg Television Thursday that he sees yields as “still pretty low.” The firm has had an underweight position on Italy’s debt, he added, as political and market uncertainties persist.
Japan’s Fiscal Discipline Wavers as Aging Pressure Mounts
Japan looks set to surrender one of its most effective tools for curbing social spending as aging pushes up health, pension and eldercare costs. Key advisers to the finance ministry recently dropped a recommendation to cap annual increases in social spending at 500 billion yen ($4.6 billion), suggesting instead that limits be calibrated with aging costs, without offering details. They also favored a five-year delay in the government’s target for achieving a surplus in the primary balance, a move that won support from advisers to Prime Minister Shinzo Abe this week. With the government’s mid-term economic policy plan to be released later this month, here’s a look at key metrics in Japan’s battle to get its finances in order. They show economic growth has boosted tax receipts and narrowed the deficit, but that government debt is still piling up. While social spending is the main driver of Japan’s swelling budgets, and public outlays have increased every year since Abe came to power in late 2012, the 500 billion yen cap has been a success. Social spending in the current fiscal year that started April 1 is projected to rise by the same amount as the cap, to 32.97 trillion yen. Economists including Mizuho Research Institute’s Akihiko Noda are concerned that removal of the cap could see spending accelerate at a time when Japan should be adopting a stricter limits. Getting a surplus in the primary balance, which measures the government’s fiscal position excluding interest payments on its borrowings, has been a key target in tackling Japan’s debt problem. Pushing back the ambitious goal from 2020 to 2025 is another sign that Japan is a long way from getting on top of the debt problem.