Fed March rate hike? ~ The FRB is moving toward rate hikes cautiously and systematically - Mr. Shunsuke Kondo

Publication date: 2017/03/04 11:06

"This week's economic indicators, including January's personal consumption expenditures deflator that moved one step closer to the Fed's target, were generally solid, but there was no dramatic acceleration in improvement. The Fed's abrupt change in stance seems to have been influenced by two events" (Nikkei online edition dated the 4th, "The Devil's Absence: Reasons for Urgent Rate Hikes")




The typical view of people who see monetary policy as "market material" is that, considering the Fed's current situation and the economy, those who can weigh the priorities of risks that must be avoided would find it natural for the Fed to move to raise rates in March.




If a March rate hike occurs, the target range for the FF rate would be 1% (technically 0.75%–1.0%). The rate paid on reserve balances is pegged to the FF rate, so the next one would be 1.0%.
The rate paid on reserve balances is pegged to the FF rate, so the next one would be 1.0%.
In Japan, there is no criticism about central banks paying interest on reserve balances, but in the United States there is a perception that the Fed's interest payments are a burden on the nation's finances in the form of reduced remittances to the government.


to the government.

The Fed is expecting three rate hikes a year, but it is not certain that it will continue to address the economy with only "rate hikes." If it raises three times and the FF rate reaches 1.5%, remittances to the government will be further reduced.



Furthermore, if the Fed believes the "natural rate" that does not allow too much easing or tightening for the U.S. economy is around 1%, it is hard to imagine it continuing to raise rates while bearing the cost of reducing remittances to the government.



The inflation the Fed is concerned about should be stock inflation rather than a flow inflation like consumer prices. This is because excess reserve balances, which have the potential to trigger stock inflation, have reached 13 times the required reserves.



The main beneficiary of stock inflation would be real estate prices; to curb this, what is needed is to raise long-term interest rates rather than short-term rates, i.e., to steepen the yield curve.



Even if the Fed raises short-term rates now, the anticipation of rapid rate hikes may cause expected inflation to fall, and long-term rates may not rise as much as anticipated.



To resolve this, rather than further raising the policy rate, it would be necessary for the Fed to reduce or eliminate reinvestment of the proceeds from maturing securities. This would exert upward pressure on long-term rates.



Currently the Fed holds Treasuries and MBS, but reducing or eliminating reinvestment of MBS would put upward pressure on long-term rates and directly affect real estate.


With President Trump’s emergence, the need for the Fed to move toward such tightening policies has grown, and it is not a matter of a "spur-of-the-moment" change or a "dramatic transformation," as the Nikkei suggests. The Fed is conducting cautious monetary policy, carefully weighing various factors. It can be said that the global economy does not falter thanks to the Fed's monetary policy.




Monetary policy should not be treated as "market material." In the end, it would only become "market material" if it simply acts as such. After all, changes in central-bank policy aim to alter the flow of money in the world. If it works well, it becomes "market material."




However, for a central bank that has lost market credibility, such cosmetic policy tweaks, as with the Bank of Japan, cannot alter the money flow and will end up simply as "market material."



Will it become only "market material," or will it change the world's money flow and thus become a real "market material"? It is dangerous to treat changes in Japanese and American monetary policy as equivalent.