No man is an island ..... not even he of the improbable coiffure

Tuesday 8th March 2016

No man is an island ..... not even he of the improbable coiffure

ref :- "Trump Take Note : U.S. Monetary Policy Increasingly Made in China" , Bloomberg Business

It would be fascinating to see the reaction of Donald Trump, now favourite for the Republican nomination for the Presidency, to the suggestion that the big decisions shaping US monetary policy were being made in Beijing rather than Washington. Given that Mr Trump can spot evidence of a foreign conspiracy in every trade pact and currency manoeuvre, one can only imagine it would be pretty volcanic ...... and both comical and a little scary at the same time.

The suggestion would be an exaggeration of course, possibly a deliberate misread mischievously designed to get up Mr Trump's nose. However it is undeniable that the decision-making process of the Federal Reserve's Open Market Committee (FOMC) is increasingly influenced by events in China and by the economic fortunes of that nation. Given that the Fed's remit is essentially domestic, that reality does not sit well with some commentators (and even some of the more hawkish Fed officials). But the close interconnection of global markets these days means that what goes on overseas will inescapably affect the US, and in those circumstances it is inconceivable that the Fed wouldn't pay close attention to outside influences ..... inconceivable, if not universally popular.

As pointed out by PIMCO's Joachim Fels, with regard to the growing impact of China on the Fed we only have to look back to the middle of last year. As summer progressed, it seemed increasingly likely that the Fed were preparing us all for a rate hike in September. Of course, we know now that China engineered a small devaluation of the Yuan in August which put markets into a turmoil and forced the Fed to stay its hand. Much to the chagrin of the hawks, the hike was postponed to December.

The "Dot-plot" (individual FOMC members' predictions for the course of interest rates) revealed by the minutes of that December meeting suggested that we would see a further four 25bp rate rises this year. That always looked toppy and was making quite a lot of assumptions not so much about the health of the US economy but the global one. Still, in theory it meant that the Fed had it in mind to impose the next hike at it's meeting next week (March 15/16). Then China allowed the Yuan to fall again in January which  provoked another, early-year rout in markets. Not entirely surprisingly, all bets for a March hike are now off.

A mostly resilient economy and a very strong labour market (which promises the return of inflationary pressures though it has so far failed to deliver) has given the hawks something to point to, at least. But the counter-argument that up to this point is holding sway is that the global financial conditions that are so heavily influenced by China and its effects on markets have already tightened US monetary conditions  --  whether by lower equity prices, higher corporate bond yields (not government, obviously) or a stronger dollar.

And talking of the dollar .....

US exports to China are not in themselves large enough (less than 1%) to make a strengthening dollar a big issue when taken on their own. But since the prospects for the rest of the world's nations (and their currencies) are so intrinsically tied to China's fate, a dollar boosted once again by rising US rates might have a very nasty impact on US trade. And don't forget dollar debt .... according to the Bank for International Settlements, emerging markets owe about $3.3 trillion. If you're earning in local currency but having to service and ultimately repay the debt in an ever-strengthening dollar ..... well, the dangers are obvious. 

So however frustrating it might be for some both in and outside of the Fed, to some extent monetary policy MUST take into account  the situation in the rest of the world, and particularly in China. How much they take it into account will vary .... we think we can guess what Mr Trump's view might be.