Whether you’re looking at the economic prospects of the West (i.e. United States and Europe) or the developing economies of the East, the same themes in central bank policy have come up. How does a central monetary authority maintain confidence in its currency while tackling unemployment and encouraging a favorable trade balance—all at the same time? (The straightforward answer? It’s a losing battle.)
While central banks in both Europe and Asia have taken similar strategic paths in this regard, the U.S. is largely on the opposite side of the spectrum due to the predominance of the dollar as world reserve currency.
This is why all eyes have been trained on the Federal Reserve, without so much as a blink, for the better part of eight years. We’ll explore some of the main narratives surrounding “Fed Week,” the two-day FOMC meeting that concludes Wednesday.
Where Is the Fed Steering the Ship?
Roughly $2.5 trillion worth of value was wiped out from the stock markets in the past three weeks alone. Although the equities market is not a perfect representation—or, in many cases, any kind of representation—of the broader economy, it is a measure of how investors feel about the biggest U.S. companies. This alone should be a sign to the Fed that the markets have begun to lose confidence in the central bank’s ability to constantly appease traders and prop up stocks.
This loss of confidence spreads beyond investors, too. Consumers—whose spending accounts for a whopping 70% of our GDP—will likewise lose faith in the economy if they see Wall St circling the toilet. Such a blow to consumer confidence (some call it a “capitulation”) would knock the FOMC off of its rate hike course. Already, expectations for whether or not the Fed will raise rates at its March meeting (the second of the year following today’s) have been slashed from 46% to 26% in a matter of weeks.
Fed Chair Janet Yellen appears to be woefully losing her bet on the dollar, as well. Yellen has reiterated time and again that, little by little, inflation will pick up and the relative strength of the dollar won’t damage the competitiveness of the U.S. economy. However, inflation has remained non-existent despite multiple rounds of QE, and the unfavorable exchange rate environment continues to eat into overseas profits for American corporations.
Worrisome Signs Heading Into Fed Week
With Fed Week now upon us, there are troubling signs both foreign and domestic regarding economic conditions. Although the Federal Reserve’s own model for recession projections shows just a 4% chance for a potential downturn, it is being contradicted by one of its own member banks. The Dallas Fed has reported that the corporate outlook in the U.S. is currently at recessionary levels already.
For these reasons, many pundits have suggested that the Fed has boxed itself into a corner where it will be forced to backtrack on its rate hike ambitions and end up cutting rates again instead. This is a problem not just for momentum’s sake, but also because rates have virtually nowhere lower to go.
This is one of several potential scenarios that could play out regarding the federal funds rate.
Moreover, the pain isn’t only (or even primarily) being felt in the U.S. In the East, China has been hammered by capital flight, economic slowdown, and government intervention in both the forex and equities markets. Japan remains stuck in a two-decade-long deflationary prison from which it has yet to hatch an escape plan. Europe is likewise battling deflation and fiscal instability. One sign of worsening economic conditions in the E.U. is the 11-month low hit by Germany’s Ifo Business Climate index. All of these issues are causing anxiety among the world leaders in economics and business gathered at the global economic forum in Davos, Switzerland.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.