Short Note 23 March 2016
Fed to turn less dovish?
The Fed is currently very dovish, having come into line with market sentiments regarding limited need for rate tightening, given subdued growth & inflation performances, reducing the expected number of rate hikes this year to two (from four), thereby undermining the Dollar, and giving lift to commodities, equities & risk currencies, with these in turn taking heart from supportive ECB & BoJ actions (and less threat seen from China following her equivalent of “whatever it takes”?).
But can this last? In an underlying sense America is steadily reviving as seen in its job growth. Once the energy depressant falls out of the price base, inflation can rise towards the 2% plus Fed target. With resource utilization steadily improving, the Fed will ultimately shift gears once again, especially if risks from the outside world lessen too. And a resurgent Fed will restart the rising Dollar engine, injecting new venom into the global system, weighing on risky assets anew. Perhaps as soon as 2H16 (even with Brexit & US election complications)? Does the Rand and other risky currencies find themselves thus in the eye of a hurricane, the next global stress test just months away, never mind what we do to ourselves politically, vying with Brazil for top billing in the farcical stakes?
The American economy is not failing, about to topple into recession. It isn't even disappointing, even if growing very slowly at 2-2.5% (rather than 3-3.5%), a understandable leftover from crisis shock a decade ago. Yet its resource uptake in new jobs created, and better utilizing under-employed labour, indicates that its recuperation is progressing well. Nothing seems to be deflecting this steady normalisation, not inner breakdowns or global influences.
This state of affairs makes it inevitable that the Fed in time will be normalising its monetary policy more fully, too, yet so far having lifted rates by only 0.25% from having been zero for seven years.
Besides a healthy risk awareness about the rest of the world, American inflation is still very subdued. In an underlying (core) sense it has been picking up speed to near the 2% target. Headline inflation is still suppressed because of favourable energy base effects a year ago. But these will disappear within months as the rolling 12-month comparison rolls on and energy prices have again lifted of late. Once this suppressant drops out, headline US inflation could jump quickly beyond 2%.
The next twist in events is not an even more dovish Fed, or an infinitely dovish Fed. At some point 2% plus GDP growth, 1.5-2% job growth and the return of 2% plus headline inflation will require a Fedfunds nearer 3%.
One can imagine what THAT could still potentially do to the Dollar, with Europe a serious laggard, Japan a failing struggler, and China manfully staying atop its structural adjustment requiring kid gloves.
If the Fed trajectory has now been lowered, coming into line with very mild market expectations, one can see a moment ahead when the pace of Fed policy normalisation can accelerate again, also reigniting the Dollar’s rise.
At that point, presumably anticipated by markets, one can expect renewed pressure on risky EM assets & currencies, Rand included.
So what we are currently experiencing globally is a bit of an Indian summer, also lifting pressure off the Rand (even as we work actively politically to do ourselves in). But that global window will close, possibly even this year once past Brexit (June) and in the runup to the Trump/Clinton face-off (November), with that outcome possibly also having a bearing.
More EM and Rand weakness ahead from global sources eventually, in addition to what we do to ourselves. Makes for a certain grimness, also where inflation and SARB interest rate prospects are concerned.
Better widen those risk margins you have pencilled in for 2016-2017.
Bruggemans & Associates, Consulting Economists
Short Profile Dr CW Bruggemans
Chairman, Bruggemans & Associates Consulting Economists
Consulting Economist, Avior Capital Markets
Consulting Economist, Ince (Pty) Ltd
Consulting Economist, Hellmann Logistics (Pty) Ltd
Consulting Economist, Bureau for Economic Research (BER), Stellenbosch
Honorary Professor of Economics, University of Stellenbosch