FOMC Between Rock and Hard Place

October 26th, 2015 6:18 am | by John Jansen |

Justin Lanhart of the WSJ writes on the difficult task which confronts the FOMC if it wishes to hike rates while most of the rest of the world is lowering rates or engaging in unconventional monetary policy.

Via the WSJ:
By Justin Lahart
Updated Oct. 25, 2015 12:41 p.m. ET

The Federal Reserve is trying to figure out when it can raise rates, but global monetary policy looks as if it is going to keep getting easier. That may make it even harder for the Fed to tighten.

The Fed starts a two-day meeting Tuesday at which it is widely expected to do precisely nothing. With economic data coming in weak since it passed on raising rates last month, policy makers are going to need more time before they are convinced the U.S. can weather a rate increase. December is still a possibility, but with overseas weakness threatening to dent the U.S. economy and send inflation even lower, it is looking less and less likely.

Meanwhile, other central banks are in easing mode. Last Thursday, European Central Bank President Mario Draghi signaled the bank is ready to push through another stimulus package to boost the eurozone’s weak economy. The next day, China’s central bank cut its benchmark lending and deposit rates by a quarter-point. The Bank of Japan is expected to step up the pace of its asset purchases, now set at ¥80 trillion ($662 billion) a year, perhaps as soon as its meeting on Friday.

The only major central bank other than the Fed at which tightening seems the likelier next move is the Bank of England—but, as with the Fed, expectations for when tightening will occur have been steadily pushed back.

With the exception of the People’s Bank of China, which still has scope to cut rates, major central banks must use unconventional policies if they want to ease. Asset purchases, or quantitative easing, has been the go-to policy, and if both the BOJ and the ECB opt to step up their programs, there could soon be the most monthly QE getting put in place globally since 2009.

The problem: With long-term yields extremely low, asset purchases don’t pack as much punch. So central banks have taken additional actions. Japan has pushed government pension funds to shift their holdings toward stocks, for example, while the ECB may cut its deposit rate, currently at minus-0.2%, further into negative territory.

For investors all of these unconventional actions serve to further reduce returns from safer assets, such as cash deposits and government bonds, pushing them into riskier ones. They also make the U.S. an even more attractive destination, which is big part of why the dollar moved higher last week.

For the Fed, that is worrisome. Further dollar strength could cut into inflation more and weigh on growth. If the Fed tightens while all other central banks are loosening, the dollar could strengthen even more, intensifying the problem.

The global squall that kept the Fed on hold in September is looking more and more like a storm that is gathering pace.

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