In the United States, all eyes are on the Federal Reserve (Fed). There are three big questions. When and how fast will the Fed begin tapering its asset purchases (QE exit)? Who will President Obama appoint to be the next Chair of the Fed? And finally, well into the future, when will the Fed abandon its near-zero target federal funds rate and start raising rates.
A qualified answer to the QE exit question may come on September 18, when the Fed issues its press release from its FOMC (Federal Open Market Committee) meeting. Whatever tapering may be announced, though, its future course is likely to be nearly totally dependent on the evolution of labor market trends. Our perspective is that we are headed for slow yet steady progress, despite some serious headwinds from fiscal policy in the US and only modest growth internationally.
Perhaps, more interesting for the long-run course of Fed policy is the emerging debate over who should lead the Fed when Chairman Bernanke’s term expires in January 2014. The two leading candidates, Janet Yellen and Larry Summers, both have strong advocates that have initiated highly visible public relations campaigns are their behalf. Janet Yellen is the consummate Fed professional and is supported by a strong contingent of Democratic Party Senators and Congressional representatives. Larry Summers has support from many current and former White House insiders. From a policy perspective, the decision may make a considerable difference down the road. Janet Yellen has been a strong backer of the Bernanke quantitative easing programs. Larry Summers has doubts about how effective the later QE programs actually have been. Republicans, however, are more focused on the fact that the last three Fed Chairs have been appointed by one party and re-appointed by the other. That is, the political importance of the appointment is substantial, given the historical precedents of Fed Chairs surviving a change of party at Presidential elections. We expect exceedingly contentious confirmation hearings in the US Senate, for whomever President Obama nominates, and these hearing may roil markets as they raise issues about the difficulties of unwinding the Bernanke QE programs.
The last question about when the target federal funds rate may rise is highly dependent on the future course of inflation. So far, after almost five years of highly accommodative monetary policy, no inflation pressure whatsoever has emerged in the US. Interestingly, one of the main reasons for this lack of inflation pressure may have been the relative strength of the US dollar. Other major currencies, such as the Japanese yen and the euro, have been challenged as well. So, there has been no feedback loop from accommodative policies to a weak currency to inflation pressure.
In Japan, recent data over the summer contained a whiff of inflation. Japan is targeting 2% inflation with the most aggressive quantitative easing program ever tried. Our focus is on the consequences of its potential success. Higher inflation rates typically mean a weaker currency and higher government bond yields. Certainly, Prime Minister Abe has both the support and the desire to keep his expansionary programs on track.
It will be hard to call a turning point for Europe, but the unemployment rate appears to have peaked, suggesting the worst of the economic slump from the fiscal austerity programs is now in the past. Europe’s big problem going forward appears to be its poorly functioning banking system, which is in no position to support an economic recovery as it still faces a need for more capital. EU-wide proposals for banking regulation seem mired in political disputes, while markets wait on the outcome of the German elections on September 22. Chancellor Merkel is likely to do better than she did in 2009, but she may still need a coalition partner. There is a risk that her current partner, the Free Democrats, will not gain enough seats to give Merkel a majority. If a new coalition party is required, that may bring uncertainty for the euro. We will have the answer soon.
China is still decelerating from its 10% real GDP annual growth rates of the past. Many analysts have underestimated this deceleration. From our perspective the slower growth is part of the natural process both of a rapidly aging economy and one that is maturing from an industrial output perspective. While China may post real GDP growth in 2013 in the 7% territory, we look for China to continue its growth deceleration in a glide path toward 3% to 4% annual real GDP in the next decade.
About the Author
As Managing Director and Chief Economist at CME Group, Blu Putnam is responsible for leading economic analysis on global financial markets, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy. Blu will explain how the term-expiration of Fed Chairman Bernanke, the possible rise in the fed funds rate and developments in Japan, Europe and China offer opportunities in the markets for your customers.
