Monday, 31 December 2018

Review of 2018 Predictions - Part 6

“A Number of Inflexion Points Are Reached” 

The US Dollar Index had been steadily rising over the last year, as it became clear that the Federal Reserve was intent on continuing to raise official interest rates. This was evidence that the return of the old rules, by which currencies rise as official interest rates rise, had occurred, in relation to the US, where, after its latest hike, the Federal Reserve has raised rates to 2.5%. This steady rise in official rates also contributed to the sell-off in US financial assets. When towards the end of the year, and following criticism of the Fed by Trump, comments from Fed officials suggested that they might be reaching the end of their rate hikes, that caused a short term sharp rally in US equities, and bonds, causing bond yields to fall back below 3%, where they had been for most of the year. 

In fact, what the Fed had said was that interest rates were approaching the range in which they would be “neutral”, in other words, being neither stimulative nor restrictive. But, this was actually no different to what they had previously said. They simply changed the way they expressed the same thing, probably to appease Trump, and also to encourage an end of year rally in stocks. The “neutral range” as it suggests is a range that extends over as much as 150 basis points, and in addition, the question is what does “near to” mean? If near to means within 25 basis points that might mean one additional rate hike, but near to might mean within 50 basis points, implying 2 more rate hikes. But, that only takes you to the bottom of that range. If a neutral position is mid way in that range, then it could mean that the Fed foresees as many as 5 additional rate hikes, whereas the spike in asset prices had been premised on the idea that the Fed might only have implemented one. 

As the wording of the Fed's analysis was further analysed, it became clear that rather than one and done, or one and pause, the Fed was on course to implement one further hike in 2018, which happened in December, and possibly four more in 2019. In fact, the Fed's dot plot suggests that it is intending three more rate hikes in 2019. That has caused stock markets to sell off once more, and as funds moved out of equities they sought safe haven once more in bonds, causing US bond yields to drop. That is likely to be a temporary flight to safety, as central banks across the globe continue to tighten monetary policy, and the ECB has now ended its own QE programme. The fact that it no longer stands behind astronomically inflated European sovereign bonds, at a time when EU budgets are likely to expand, as is happening in Italy, and with European banks again looking increasingly vulnerable, is another reason that hot money has flooded towards the safe haven of US Treasuries. But, with Trump ramping up US spending, and exploding the Budget Deficit through tax cuts, at the same time that the Federal Reserve is set to reduce its Balance Sheet by around $800 billion in 2019, as it redeems maturing bonds, a rise in US interest rates seems inevitable in 2019, with a consequent effect on global yields, and on asset prices. 

US interest rates did not rise faster, in 2018, because of the effect of the three year cycle, and because Trump's trade war, and Brexit held back growth. Estimates of 2019 growth contain a lot of inertia from 2018 conditions. If Trump's trade war results in some settlements, and if Brexit does not happen, or happens in name only, then many of the current impediments to trade and investment will be removed, and growth estimates will be quickly revised upwards. If not, then in the current conjuncture, it will only result in a relative impediment to growth. A short term hit will simply result in a global restructuring of trade and production. Tariffs imposed by the US on China, may result in an increase in US production of those commodities, but at a higher cost, reducing productivity, and thereby a relative decline in output, but with an absolute rise in output. The same applies to China, and trade will be redirected into other channels, including a more rapid expansion of domestic markets, an increase in trade between economies where no such tariffs exist, and it will encourage further trade deals between large economic blocs, such as the EU with China, Japan, and so on. The loser will be those relatively smaller national economies, such as a post-Brexit Britain, unable to impose their own protective measures, because of their lack of size and importance. 

This continued rise in global growth, though at a relatively lower level than it would be without trade restrictions, means that the demand for labour will continue to rise, and will rise at a relatively faster rate, due to lower levels of productivity, due to the limitation on the global division of labour. It will mean that the value of labour-power thereby rises faster than it would have done, due to this impact of relatively slower productivity growth, and as the demand for labour rises, that will be compounded by a higher market price for labour-power, i.e. wages, which impacts the rate of surplus value, so squeezing profits. That means that the demand for money-capital to finance the increasing level of growth, pushed forward by an increasing demand for wage goods, as more workers are employed, and wages rise, will further push interest rates higher. 

Expect, in the new year that the estimates for US and global growth will be raised, and that US wages will start to move higher. Higher costs will push US inflation higher, as liquidity flows out of financial assets, as those asset prices continue to decline as interest rates rise. 

In short, the prediction has been confirmed, and the underlying dynamic of the prediction continues to operate into the period ahead. 

No comments: