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Update: Taps Off

By beled | November 1, 2016

Extract from the September 2016 quarterly report:

In our view it is incorrectly perceived that US monetary policy is still very loose, partly due to excessive focus on the FOMC’s policy target rate. Of far more importance are other market-related interest rates e.g. LIBOR (chart 1) which indicate that US monetary policy is not as loose as is generally perceived, something on which US Fed Chairperson Janet Yellen has recently commented.

Chart 1: “They” have already tightened


Actually the Fed has been tightening monetary policy since mid-2014 when it started tapering the rate of its asset purchases, it just didn’t reflect in a rising headline Fed funds rate. In our view it is not by chance that this tightening coincided with a collapse in liquidity-sensitive cyclical assets such as emerging markets and commodities. These prices correctly anticipated that US growth would be adversely affected, which is borne out by the charts below:

Chart 2: US durable goods orders                                            Chart 3: US manufacturing sales


We conclude that (1) US monetary policy is tighter than generally perceived and (2) if new stimulatory measures are not forthcoming the US will enter recession. This could be through a resumption of quantitative easing (QE) and/or easier fiscal policy (increased government spending and/or tax cuts). Despite a high debt to GDP ratio, this is justifiable in the short term because (1) the US Treasury can still borrow at very low interest rates and (2) US tax rates are too high, as evidenced anecdotally by tax avoidance by several major US companies e.g. Apple, making the news recently. In the medium to long term, growth is the only palatable way to reduce fiscal deficits, a fact which is receiving increasing recognition amongst economic policy-makers.

Similar arguments apply to the Eurozone despite QE still being in force – their rate of monetary expansion is still only a fraction of that of Japan on a relative basis and Eurozone fiscal policies remain austere. Only Japan with both stimulatory monetary AND fiscal policy appears to be grasping the nettle, but it is our belief that this will extend inevitably to other major economies in due course. In all cases inflation appears to be a distant risk.

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