Monetary policy U. S.

Path of Fed rate normalization

The market is looking at four major risks these days. First, the slump of commodity prices, especially the oil prices; second, the risk of structure adjustment in China from export-led economy to consumption-led economy; third, slower than expected growth in the U. S. since the second half of last year; and fourth, the diversified path of interest rate policies between the U. S. and many of the rest countries.

The low oil prices and the slow growth in the U. S. are more connected. Energy is a very important economic part. Low oil prices shrink the economic sizes of the energy sector, and also reduces capital investment in the energy sector and other supporting industries. I think the current cycle of oil slump has bottomed out and the oil prices will recover upon production cuts (see [3]), although I do not know to what level the prices can recover.

The economic structure change that is going on in China, has risk but I think the Chinese central bank and the government have substantial tools to deal with them. One policy shortcoming in the past was that the Chinese currency has been overly appreciated. Some was due to external pressure. It is important to adjust the economy toward consumption-oriented and therefore becomes more sustainable in the long term. But that does not mean to suddenly stop exports. I think it is appropriate to devalue the Chinese currency going forward, in a controlled pace, so that exports can be recovered a bit. This will ease and stabilize the small businesses in China. There had been large capital outflows from china in recent months. This is natural as investors are expecting the US policy rate increases, in contrast of potential policy rate cuts in China. The capital flow seeming large in size, is however well within the China’s own ability to make up.

Looking ahead, I think it will remain true of the monetary policy diversification. Amid the turbulent stock market since the new year, some analysts thought the U. S. Fed would reverse the normalization course and even cut the rate to negative. I think there is little chance for the Fed to go back, although I thought in last December that the first rate increase was premature(see [1] and [2]). Since the Fed has made up its mind to normalize the policy rates, the course is hard to reverse, as the Fed can not afford the potential damage of its creditability, however the pace can be slower. The diversification will be characterized by more eases from the rest of the world. In this sense, I think the U. S. dollar will strengthen further, and its recent retreat is short term and transitory.


[1] Kevin economy note on Nov. 11, 2015, come on Fed, be patient.

[2] Kevin economy note on Dec. 19, 2015, rate lifting.

[3] Kevin economy note on Jan 12, 2016, crude prices to recover soon.

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