Breaking News: The Fed is now in charge of the world
5th April 2016
To borrow a line from Star Wars Episode 7: There has been an awakening…Have you felt it? And…The US Fed is evolving…Have you felt it?
The Federal Reserve Bank (Fed) has just de facto broadened its mandate from being a US domestic central bank to becoming the world’s global central bank. The speech from Chair Yellen on March 29th sent a thunderous message to investors globally…That the Fed will assume the role as the world’s Central Bank.
Why and how?
Why: The Fed wants to weaken the US Dollar to support global growth and emerging markets. This is very different from its original mandate. Remember that the US Fed was created in 1912 with the mandate to buy corporate bonds and be a lender of last resort to US banks. Its role was purely domestic:
Source of the two above charts: Bloomberg, AllianzGI, as of 31.03.2016
Both the current unemployment rate and the rate of core inflation would historically have prompted the Fed to hike interest rates. But Yellen said NO at her speech…Citing “global concerns”, namely weak growth in China, Japan and other Emerging Markets. So US domestic conditions have been superseded by problems in foreign countries.
It is clear to me that the Fed will not raise rates this year…And it is ignoring its long-held mandate and focus on US inflation and US employment.
How: The US Dollar is arguably the world’s currency, and US monetary policy is transmitted around the world via the US Dollar.
The Fed realises that a strong US Dollar draws the global flows of funds to the US, and away from Emerging Markets. Hence, the Fed purposely will not hike rates, which would in turn strengthen the US Dollar. Perhaps the Fed realises that China needs to continue to slowly weaken the CNY, and considers that not hiking rates could help to reduce global markets volatility.
US Dollar index since 2012
Source: AllianzGI, as of 31.03.2016
Investment Implications: Reflation and carry trades
1. Focus on US 10 year Inflation Linked Bonds…Fed weakening US Dollar is inflationary to US
2. Focus on Emerging Market debt in US Dollars and selectively local EM currencies
3. Short US Dollar vs. a basket of commodity currencies
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