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Earth to Janet Yellen: 3 reasons the Fed is misguided

Coming so soon after the FOMC’s ill-advised Interest Rate hike last month, yesterday’s FOMC statement underlines how out of touch the Federal Reserve has become about global financial market and economic developments.

Indeed, by giving no intimation that it is ruling out a March Interest Rate Hike, or that it is reconsidering the interest rate hike path upon it appears to be on, the Fed seems to be repeating the same mistake it made in 2008 — that of being overly sanguine about the US and global economic outlooks. Minutes of the 2008 FOMC meetings reveal that as late as August 2008, the Fed had no inkling about the magnitude of the sub prime crisis that was about to hit the US and global economies later that year.

Federal Reserve Board Chair Janet Yellen prepares to testify before a House Financial Services committee hearing, July 15, 2015. REUTERS/Yuri Gripas.

Federal Reserve Board Chair Janet Yellen prepares to testify before a House Financial Services committee hearing, July 15, 2015. REUTERS/Yuri Gripas.

There are at least three reasons why the Fed is mistaken about now not pursuing a more dovish monetary policy. The first is that the credit cycle has turned and that the market has already raised Corporate Borrowing Costs substantially. Market estimates consider that the sharp market interest rate rises in recent months, especially in high-yield corporate borrowing costs, constitutes the equivalent of between three and four increases in the Fed’s federal funds rate. If the market is doing the tightening for it, it would seem that there is little reason for the Fed to further increase its interest rate.

The second reason is that the Fed is now increasingly out of step with other major central banks, which are in an aggressive  loosening phase of their monetary policies. Only last week, the European Central Bank left little doubt that, at its next meeting in March, it would step up its unorthodox monetary policy action to boost the flagging European economy. Any further increases in US interest rates in that environment would risk causing a further significant dollar appreciation — which could be highly detrimental for US export prospects.

The third and most important reason why the Fed seems misguided in not backing off from its interest rate raising path is that serious trouble is brewing in the highly indebted Emerging Market Economies. This is not so much a question of the Chinese economy slowing,  thereby causing an international commodity price bust. Rather, it is the fact that other major emerging market economies like Brazil, Indonesia, Russia, and South Africa are all experiencing currency collapses and very large capital outflows. That is bound to  drive these economies into painful economic recessions.

It seems to have escaped Mrs. Yellen’s notice that the emerging market economies now constitute over 40% of the global economy. This means that any reversal in these economies can have serious implications for the global economic outlook. More troubling yet, it also seems to have escaped Mrs. Yellen’s notice that these economies’ corporate sectors now have total debt of around US$23 trillion, of which US$5 trillion is dollar-denominated. One would think that if emerging market currencies remain weak and if their economies falter, their corporate sectors will soon start defaulting on this debt. This has potentially serious implications for the US financial system, considering how very large is that emerging market indebtedness.

The late Rudi Dornbusch, the renowned MIT economics professor, used to say of the Mexican Central Bank that he could understand their making mistakes. However, what he could not understand was how the same people made the same mistakes time and time again. Hopefully, the Federal Reserve will soon back off its relatively hawkish monetary policy stance so that the same might not be said of it as was said of the Mexican central bank.

Source: New AEI Feed
Earth to Janet Yellen: 3 reasons the Fed is misguided



This post first appeared on RightForAmerica | Left And Right… On Purpose…, please read the originial post: here

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Earth to Janet Yellen: 3 reasons the Fed is misguided

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