Structural Reforms and Absorbing Volatility
By JC Collins
The normalization of monetary policy is on the agenda. At least in the United States. The ending of stimulus and quantitative easing, along with a reversal in interest rate trending, is leading the monetary charge towards the new and emerging economic framework.
Though some nations may lag behind for a short period of time, a policy of shifting away from stimulus and enacting monetary structural reforms is the new game. The Federal Reserve began this macroeconomic process back in December when it lifted rates for the first time in nearly a decade.
Since then there has been enhanced market volatility and global growth concerns. This has stalled follow up rate increases for the time being.
But now that the initial response to the Fed’s rate increase is beginning to subside, some stability is beginning to return to the system, and investor confidence is growing again. The back and forth strategy of implementing rate increases and managing the expected pressure on markets will continue for some time.
The Fed fund futures contract is now suggesting that rate increases are back on the table. The odds of an increase next March is all but certain, and is fully priced in. But that doesn’t mean we will not see increases between now and then.
With so much happening this year around the monetary transition itself, such as broader structural reforms across all economies and nations, the rise of the Chinese renminbi and its inclusion in the updated SDR this October, and a suggested larger role for the SDR through the G20, we can expect that the ability of the international monetary system to absorb additional rate increases will elevate incrementally.
These changes will cause adjustments to the Fed fund futures contract prices and increase the odds of future rate movements.
The next Fed meeting on rate increases is March 15th. Whether enough stability has returned to encourage and support the next increase is not so much important as the fact that there will be further rate increases in the months to come.
The Fed is working alongside Chinese monetary authorities to deleverage the international framework from a percentage of USD denominated instruments. The rebalancing between currencies is meant to offset the large imbalances which have developed over the last seven decades from the broad use of the dollar as the reserve asset.
The more the RMB becomes internationalized and the more liberalized and open China’s domestic financial market becomes, the more the Fed will be able to implement incremental rate increases.
In the post How China is Deleveraging from the USD, I stated the following:
How long this takes will be influenced by many factors. Some which include the ability of American and Chinese authorities to manage the transition pieces and maintain a slow deflating of the USD denominated bubble without undermining each other’s positions. Something which is detrimental to both.
The trend which can be determined from the above scenario is a gradual depreciation of the US dollar against the currencies of its largest trading partners. This also means an appreciation of the renminbi.
The recent collapse in crude and other commodities will be reversed as renminbi denominated development loans spur massive infrastructure development in emerging markets such as India, Malaysia, Thailand, etc.. It is estimated that Asia alone will require $8 trillion worth of infrastructure development over the next ten years. This trend bodes well for both the renminbi and commodities.
We are already seeing the reversal of commodities prices and the US dollar has been experiencing some depreciation over the last few weeks. Whether this trend remains in the coming weeks and months will have to be seen.
If it does, we could see the next rate increase by the Fed as early as March 15th, though I would suspect that there are greater odds for an increase in April. As long as growth remains steady and the system stands on both feet.
Whenever the next rate increase comes, we can also expect a similar level of volatility in the first few months after. The ability of the international monetary authorities to manage that volatility will depend largely on the structural reforms which have been implemented at that time. – JC