Fed's monetary policy conundrum

By Zhang Jingwei
0 Comment(s)Print E-mail China.org.cn, May 26, 2016
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To raise the interest rate or not, that is the question faced by Janet Yellen.

Despite altercations between hawks and doves in American politics, the bipartisan Fed chair has maintained a professional standing. From former chairmen Alan Greenspan to Ben Bernanke, the Fed chairperson has remained unfettered by party politics. But now GOP presidential hopeful Donald Trump played on the party affiliation of current chair Janet Yellen and said that he would let Yellen go once he got elected. But he wanted a policy of low interest rates to stay, he added.

Trump's remarks have been criticized by mainstream American politicians and the public. But it also highlights changes in the U.S. political ecosystem: Whether it's Republican candidate Donald Trump or Democratic candidate Bernie Sanders, candidates have demonstrated a more and more prominent anti-globalization stance. Trump's tampering represents an interference of politics with the Fed -- virtually the world's central bank -- and in some way also puts more pressure on the Fed's monetary policy.

It's not clear whether or not the Fed will raise the interest rate in June. The issue has actually gone beyond America and is increasingly influenced by other markets. The negative interest rate policies in Japan and Europe have put tremendous pressure on the U.S. dollar, and a rate hike will bring more trouble to the dollar's exchange rate and exports. The upcoming referendum in Britain on leaving the European Union also plays a role in the issue. In emerging markets, a rate rise would bring a new round of currency devaluation and capital outflow. The recent turmoil in Brazil has also become a new problem.

The Chinese and American markets are intertwined more than ever before. Last August, the Fed put off a rate rise due to turbulence in Chinese stock markets. The rate hike at the end of last year, which had a negative impact on China's markets, has made the Fed more wary of the level and frequencies of rate hikes this year. As Japan and Europe maintain negative interest rates, the overall stability in Chinese and American monetary policies has circumvented the risk of a global currency war to some extent.

Though the expectations of the Fed rate hike have gone from four to five times a year to two to three times a year, the uncertainty risk it poses to the global market is still difficult to assess. John Williams, the president and chief executive officer of the Federal Reserve Bank of San Francisco said that two to three rate hikes this year "make sense" given the continued growth in the U.S. economy and a low unemployment rate. Atlanta Fed President and CEO Dennis Lockhart also said that a rate hike is possible. As a result, the American stock market closed lower on May 17, and markets in the Asia Pacific region were also dragged down, including Hong Kong's Hengseng index, which lost almost 1.45 percent.

China's RMB exchange rate has also seen fluctuations. The gap between offshore RMB exchange rate (CNH) and onshore RMB (CNY) has widened to the highest level since February. Fortunately, the Chinese yuan has not been greatly affected by speculation, perhaps due to fears of market-supporting moves by the Chinese central bank.

If the FED raises the interest rate in June, a new market tumult will spread from the U.S. to China and from the Asia Pacific to the entire world. The usually cautious Yellen will perhaps not be so willing to raise the rate. However, the Fed, including Yellen, is faced not only with different voices from within itself, but also open to the criticisms from American politicians in the heated presidential election – for example, Donald Trump.

Is the FED too hesitant, and Yellen too prudent? I believe that Yellen's predecessor Bernanke was too bold -- several rounds of quantitative easing have undermined American economic vigor and the dollar's credibility despite the recovery it brought. As a consequence, despite strong signs of recovery, American economic growth lacks persistent force and hence needs a long-term rest. Yellen is well aware of that and therefore not ready to revert to pre-crisis monetary policies.

More importantly, a post-crisis American market cannot play a QE game as willfully as it did before but has to consider both sides before making a decision. It has to assess the global effect of its monetary policy and try to maintain market balance.

If the Fed doesn't raise the interest rate, it will be cornered by negative interest rates in Japan and Europe; if it does, it will rattle the global market. More paradoxically, when people like Donald Trump try to make an issue out of the Fed, the monetary institution is not only faced with the burden of being the world's central bank, but also becomes mired in politics. At present, the Fed does not seem to have decided on whether to raise interest rate or not, and neither has Yellen found a way out of the conundrum.

Yellen has made other monetary efforts, for instance, scaling down the Fed balance sheet. The Federal Reserve Bank of New York announced earlier last week that it will conduct a small value Treasury sale operation, which will occur on May 24. The sale will not exceed a face value of US$250 million and will be limited to Treasury securities maturing between 2 and 3 years from the date of operation. It will also conduct two small value agency MBS sales operations, which will occur on May 25 and June 1, with a total value not exceeding US$150 million. But all these do not signal a fundamental change in American monetary policy.

With June around the corner, the world is watching the U.S. If the Fed decides not to raise the interest rate, a postponed rate hike in the latter half of this year will put more pressure on the Fed and have a greater effect on the market. Is Yellen ready for it?

Zhang Jingwei is a researcher with the Charhar Institute.

The article was first published in Chinese and translated by Zhang Lulu.

Opinion articles reflect the views of their authors only, not necessarily those of China.org.cn.

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