Rockefeller Treasury Services, Inc. Analytics | 5 of January

Posted 05 January, 2017

The Fed may be shooting itself in the foot. The minutes reported that “about half” of the members see potential expansionary fiscal policies as the biggest upside risk to their forecasts, but a gradual pace of hikes is still the appropriate path until we have hard facts. Uncertainty is very high.


It is perfectly accurate to say we have nothing specific on fiscal expansion, which includes tax cuts. We don’t. And that does raise the level of uncertainty. So, until we know more, keeping to the already established “gradual” path is the reasonable thing to do. But the Fed’s ideas about how to communicate is weirdly out of date, or at least out of sync with how even the most sophisticated people are looking at conditions today. We could write a better summary for the Fed in two minutes: “We have to stick to our policy of gradualism until we have new expansionary fiscal policy, as promised by the presidentelect. If we get that fiscal policy, we expect to respond promptly. We will not act rashly but intend not to get behind the curve.”


The Fed is not bungling. It’s just being hide-bound and pompous. It’s so worried about setting off a panic that it mumbles.


Where we do see bungling is the UK, now that the UK ambassador to the EU, Mr. Rogers, resigned because the May government is engaging in “muddled thinking.” The Brexit negotiating objectives are not laid out and the UK doesn’t even have a proper negotiating team. The PM may be so worried about showing her hand that she risks a disorderly process and a hard Brexit. For some reason, probably good economic data, sterling is not being punished. Yet.


What may be a bungle is taking place in China. We are impressed by the comment by a local banker that the liquidity squeeze intended to halt the outflow of yuan means capital controls are not working or not expected to work. They were announced last fall but became operational on Jan 1. Reuters reported this week that sellers are not lining up at bank doors to remove their max $50,000, so presumably the squeeze is pre-emptive. What does China expect that made them do it? One answer is another, marketgenerated crunch over the Lunar New Year holidays, which starts Jan 27. Another idea is trying to keep the money at home and directed to the stock market, which famously crashed a year ago. The yuan may have fallen 1% but the Shanghai rose 0.21% at the same time.


Another idea is that China really does expect a trade war with Trump. The party-owned Global Times newspaper editorial today says "There are flowers around the gate of China’s Ministry of Commerce, but there are also big sticks hidden inside the door -- they both await Americans." This is the response to the new trade rep Lighthizer, who is seen as anti-China. Bloomberg reports “The latest salvo from state-run outlets followed others last month aimed at Peter Navarro, a University of California at Irvine economics professor and critic of China’s trade practices whom Trump last month named to head a newly formed White House National Trade Council. Those picks plus billionaire Wilbur Ross, the nominee for commerce secretary, will form an "iron curtain" of protectionism in Trump’s economic and trade team, the paper wrote. The three share Trump’s strong anti-globalization beliefs and seem unlikely to keep building the current trade order, it said, adding that they will be more interested in disrupting the world trade order.”


What’s the difference between disrupting and bungling? Disrupting has an end-game in mind. A plan, in other words, such as “Reduce the trade deficit with China by x% over y number of years.” It’s almost certain the Trump gang has no such stated goal, at least not yet. As for China, to threaten “big sticks” against Americans needs to be taken seriously. The editor of a party-owned newspaper doesn’t throw out threats willy-nilly. And if SocGen is right that the squeeze that halted the currency drop to the round number 7 was really directed at disrupting the dollar rally, we have a problem.


The dollar doesn’t need capital flows from China to contribute to its rally. It does need the second largest dollar reserve holder to maintain its holdings. One of those big sticks is the threat of selling a big chunk of those dollar reserves. The announcement effect would trash the dollar fast, and probably hard. But maybe the Trump gang doesn’t care about the dollar being strong. After all, a strong dollar is broadly seen as anti-inflationary, while Trump wants higher yields. Pro-inflationary policies, like a weaker dollar, are okay if they lead to higher yields. Inflation leads growth if capital spenders rush to get in before costs surge. For all we know, the Trump gang wants a weaker dollar. If it’s China that delivers it, okay.


We call this the Bre’er Rabbit strategy. “Don’t throw me in the briar patch,” Br’er Rabbit said, when that was exactly what he wanted to make his escape. Rabbits love briar patches. It looks like Trump likes briar patches, too. To engineer the dollar lower to aid exports and repair the long-standing trade deficit is a policy the US has not attempted in decades. And the cost could be terribly high. It’s the Treasury that “manages” the dollar, not the Fed, but it has taken a hands-off stance since before Greenspan (1987). A pro-active Treasury and a shoot-from-the-hip president on the subject of the level of the dollar would be a wild departure. Eeek.


Overall, we think the dollar uptrend is safe and will proceed higher after the current flop. But we also want to identify the risks to the dollar rally scenario, and Trump is at the top of that list. Sometimes the list of risky worries can become so big that it overwhelms the actual data and real-life news. That would cause a reversal in sentiment. We’re pretty far from a reversal, so far. But remember that since floating in 1973 and France’s objection to “extraordinary privilege” later that decade, the bias has traditionally been against the dollar. It wouldn’t take much to tip it back that way, Brexit and euro-sclerosis notwithstanding.


By Barbara Rockefeller


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