What is the Fed saying?
Not much, from the looks of it. Perhaps suddenly realising the enormous popularity it has with the market and other policy makers, the Fed has turned reticent and shy, limiting verbosity, careful not to spark neither panic nor exuberance. With great power comes great responsibility, someone said.
What has the Fed listed as the circles of concern? These are:
- measures of labour market conditions
- indicators of inflation pressures and inflation expectations
- readings on financial developments
- readings on international developments
The first two are the mandates. The Fed may have been scared by the taper tantrums to have put in financial developments. As China was a surprise factor last time, this time, international developments are now being formally acknowledged. The inclusion of the last two factors is an evolution of the Fed’s policy management, much more formally acknowledged than by Volcker, Greenspan, or even Bernanke.
Overall, the Fed statement read rather tersely, as if its composition had gone through a Hemingway editor , where superfluous words were stripped out. The composition is not unlike someone who is playing poker and not wanting to give any sentiments away. That, or they really have no clue and along with the rest of the world, is in a wait-and-see mode, play it by the ear, as many publications this morning have claimed.
It goes to follow, that the question should be, “What are we waiting to see?”
The most obvious answer would be for the oil price to stabilise. However, that is not a purely economic question, it is a political one too. Even the members of OPEC are at a loss as to what they should do. At risk is their future as oil producers. The resolution of optimal level of production is still a long way away, beyond March at least, I would say. In the short run, a good enough cut may be achievable as the most recent news (gossip?) is that all oil producing countries may cut production by 5% (NOVAK).
Even if oil prices stabilise soon, at what level would it finally begin to exert inflationary pressure or alter the expected rates of interest? USD45? USD60? The low probability of oil reaching above USD65 this year, coupled with the low likelihood of interest rates budging higher, make energy prices a non-issue. For now, energy prices are a red herring in determining the near future of the path of interest rates.
The next answer would be China. Some would argue that the fear about China is overblown, as the ‘data’ is saying otherwise. They fail to see though, that because we are not quite sure of the validity of the data provided, the proxy indicator that we watch is the behaviour of the Chinese themselves with the assumption that they know more than we do. If the Chinese are behaving ‘funny’ and are nervous with their own assets, then we get ‘funny’ and nervous too. If the Chinese look and act comfortable in their situation, then the rest of the world will too. Beyond often cited capital outflow, this is not given by formal data but rather by implied figures.
The default rate of Chinese companies could be an indicator. Some companies in China have now turned towards P2P for funding to service their debts. (Think about that kind of risk, for a moment.)
But again, the transition of China into something or other that we can’t foresee yet, (although we keep saying service industry, international currency, etc. – it could turn out to be an entirely different thing altogether) whatever it is they are transforming into, could take a while. More than a year a while. Thus, despite the possibility of devaluation around the next Fed meeting, the conditions in China should not be used to weigh on the path of interest rates for the U.S.
What is the Fed not saying?
Ultimately, it may be the strength of the dollar that is the priority. The trade weighted dollar US index is the chart that we should look at to peek into the minds of Yellen and gang. All out currency war is no longer fashionable, but that is the issue of the day.
Any country that can depend on its domestic economy during tough times and not on foreign trade for its survival and economic health will fare better than those who can’t. In this regard, the US doesn’t have to worry – it is one of the most closed economies (only above Brazil) in the global context.
However, although one might think that the dollar strength might not matter much for the GDP, it does for the S&P, where foreign income now buys fewer dollars and therefore depresses reported earnings.
From the Washington Post,
That’s not good when you get two-thirds of your revenue overseas.
The strong dollar, in other words, has become an earnings albatross for Apple. It’s getting paid in currencies that aren’t worth as much, and, at least up till now, it hasn’t made up for that by raising prices that much lest it lose market share.
With the Fed now super-sensitive to the market, this is a really important metric it needs to consider.