Wednesday, February 15, 2017

Fed and Dollar Update

Janet Yellen, Chair of the Federal Reserve, testified before the Senate Banking Committee yesterday.  I offer my commentary on the NYT article linked-to above for your edification.  Emphases added mine throughout:

Senator Sherrod Brown of Ohio, the ranking Democrat on the committee, asked Ms. Yellen whether regulation had reduced the risk of financial crises.

“I believe the financial system is much more resilient than it was,” she said.

Are businesses unable to get loans? No, Ms. Yellen responded.

Are banks unable to compete with foreign rivals? No, she said.

Are consumers better protected against predation? Yes, she said.

OK.  So the current Fed Chair is on the record saying that Dodd-Frank and other regulatory innovations of the Obama era have made the financial system more resilient ("able to withstand or recover quickly from difficult conditions"), that businesses are not hampered in their ability to raise money, that banks are not at a disadvantage vis-a-vis their foreign rivals, and that consumers are better protected than they were.

Janet Yellen is a Democrat, but she is more hawkish and conservative than her Republican predecessor, Ben Bernanke, who oversaw the Fed during the introduction of most of these regulations, and approved of them.

We have a clear choice here: believe the Fed Chair or believe the average Republican politician, who argues that business cannot get access to credit and that regulations have gone too far.  Not always in life do we get such a clear choice of whose story to believe.  


Ms. Yellen was invited to Capitol Hill to deliver a biannual report on monetary policy to the Senate Banking Committee. And she found time to tell the committee that the Fed remained pleased with the performance of the economy and expected to continue raising its benchmark interest rate, although she dodged questions about the timing.

The Fed thinks, in contrast again to the predominant Republican belief (as well as the belief of many Democrats), that the economy is doing just fine.

The unemployment rate was little changed over the last year, standing at 4.8 percent in January, even as the economy added an average of 190,000 jobs a month during the second half of 2016, and an additional 227,000 jobs last month. That indicates people are returning to the work force. Inflation also showed signs of rising to a healthier level. Prices increased by 1.6 percent during 2016, a percentage point more than in the previous year, although that is still below the Fed’s preferred 2 percent annual pace.

Ms. Yellen demurred when asked directly whether the Fed planned to raise rates at its next policy-making meeting, in March. But she reiterated the Fed’s December prediction of three increases in 2017, raising the Fed’s benchmark rate from its current range, 0.5 percent to 0.75 percent, to a range of 1.25 percent to 1.5 percent.

So inflation is below the Fed's own target, but the Fed is still planning on raising rates. 

If that sounds stupid or contradictory, that's because it is.  The Fed may be staffed with intelligent people, but intelligent people can engage in fetishistic wishful thinking just like everyone else, and there is no bigger fetishist in the modern age than the Inflation Hawk.   

People hear the word "inflation" and lose their minds.  That sounds like Weimar Germany! Or Zimbabwe! Or the Carter era!  That's what a "weak" dollar will do to you!  We need a strong dollar!  Can't let the dollar have insufficient strength!

Actually, the stronger the dollar, the more difficult it is to engage in economic activity.  The more difficult it is to hire people.  To give them raises.  The less sense it makes for consumers to spend the money they've got, circulating it in the economy, allowing businesses to grow.

The Fed is misguided when it comes to the issue of interest rate hikes.  Interest rate hikes are premature.  Let those people who are finally rejoining the labor market after years of sitting at home, saying, "What's the point?" do so.  Let inflation hit 2%.  2% inflation is not going to lead to bread lines.  2% inflation is, if anything, a hair conservative.

In this regard, the Trump administration - rhetorically, if not in substance yet - has the right point of view.  We need more inflation; we need more economic activity.

Of course, there is the matter of what Trump says versus what he knows.  We know that President Trump recently called freshly-fired national security advisor Michael Flynn to ask whether or not a strong or weak dollar is "good".  This is deeply troubling.  

The Trump administration also still hasn't rolled out its infrastructure plan.  We have little to no idea what this plan will actually look like.  This is injecting a lot of uncertainty into markets, into the Fed's prognostications, into the lives of everyone who wants to know what the plan is.

If Trump does go big on infrastructure, however, Janet Yellen may be stepping up to the plate to put the kibosh on any inflation that might ensue:

Changes in fiscal policy have the potential to scramble the Fed’s economic outlook. Mr. Trump has repeatedly called for measures to stimulate economic growth, like tax cuts and infrastructure spending. Ms. Yellen and other Fed officials have suggested that the central bank would seek to offset such measures by raising interest rates more quickly because the Fed judges the economy to be growing at roughly the maximum sustainable pace already. But she reiterated that before acting, the Fed would see what Congress may do.

Do you think the economy is growing at the maximum sustainable pace?  I suppose if it grew at this pace for several years on end America might be Made Great Again, but I'm not convinced.  I could see the pace speeding up a hair, and based on this last election, I think a lot of my fellow Americans are with me.

Still, Fed's gonna Fed, and I'm not convinced that if Donald Trump were to fire to Janet Yellen and replace her with a new Fed Chair that his appointee would be any less hawkish than Yellen.  Inflation Hawk-ery is in the Fed's very blood.  (If you want to dip your toes in Fed history, I cannot recommend this long, but brisky-written and extremely gripping book highly enough.)


Gary Cohn, the president’s chief economic adviser and a former Goldman Sachs executive, said this month that bank lending had been constrained by changes requiring banks to raise a larger share of funds from investors rather than lenders. Such funding protects a bank in the event of losses, because it need not be repaid.

Mr. Cohn described this regulation incorrectly, saying banks were required to “hoard” capital. In fact, capital is a kind of funding; it is not held or hoarded.

Under questioning by Senator Elizabeth Warren, Democrat of Massachusetts, Ms. Yellen defended the importance of capital standards and corrected Mr. Cohn.

“It’s not a requirement that they stick it in a safe and it can’t be used,” she said.

Ok, this is, again, very troubling.  Maybe President Trump doesn't understand how the dollar works, but surely his chief economic adviser should understand how capital requirements work?!? I understand that, and I'm a legal secretary for a living.  Holy cow.

For those who, like Mr. Cohn, do not understand how capital requirements work: in a nutshell, capital requirements are the amount of money a bank must keep in reserve to conduct business.  They can totally "use" this money.  They just can't be so over-leveraged that, when many parties at once decide to cash in their chips (as in a market crisis) they are unable to pay back their creditors.  It's not rocket science, and the increase in capital requirements during the Obama years is, in fact, one of the most substantive accomplishments of the Obama years.

Anyways, because Donald Trump is saying "FULL SPEED AHEAD!" and the Fed Chair is saying "Now now, nice and easy," the dollar market is filled with uncertainty.

However, the dollar is steadily creeping upwards, rising for the 12th day in a row which, actually, breaks a historic record.  Why is the dollar behaving this way?

In a nutshell, the Fed has been saying for a good while now that a rate hike is coming.  Yellen won't say when, which I'm sure irritates many, but the Fed is a known factor and if they say a rate hike is coming, it's likely coming.  A rate hike leads, other factors aside, to a stronger currency.

The Trump administration, by contrast, says an infrastructure plan is in the works, but what is it?  It's been a month now and everyone - Republicans, Democrats, you name it - have no clue what it's going to look like.  Will it be $1 trillion over ten years?  Will it be a quarter of that size?  Will it even happen at all?

Therefore if you're in the dollar market it makes sense to listen to the dependable Fed and put the words of the chaotic Presidential administration in the backseat.

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