The great Central Bank unwind

Little did I know that over the late 1980s and the 1990s, the central banks would rise in prominence to become arguably the dominant influence on financial markets and this trend has probably only strengthened over the last decade or so – central bank governors are now known even within the popular press. However, it now seems likely that the pendulum of popular opinion and market sentiment is likely to turn against these institutions as they face arguably one of their most difficult years since the late 1970s. Arguably, all of the major central banks are facing a potentially daunting 2017 as some of their past mistakes – or necessary policy compromises – come back to haunt them and as a result we suspect that 2017 will be a most interesting year for investors.

For example, in the USA we find that despite some evidence that in aggregate the US economy is still working at below full capacity and employment, the Federal Reserve of course elected to raise interest rates last month. In reality, we suspect that there were four motives behind the move: to help to improve potential profitability in the banking system (not an objective that they will have wished to advertise but an important and we believe justifiable one nonetheless); to validate the recent upward move in market-determined interest rates; to provide some impediment to the extreme levels of corporate financial engineering and speculation that has been taking place; and finally to give the central bank some two-way optionality on future interest rate moves should circumstances demand. Consequently, we would describe the Fed’s actions as representing a mixture of prudence and opportunism, both of which of course have some merit.

As to the outlook for rates, we continue to believe that the FOMC may be being rather too optimistic over the outlook for the economy: the ‘freak’ rise in soya bean export shipments over the third quarter of 2016 will have created a high comparison period of net trade, thereby making it more difficult for the latter to contribute to headline GDP in the near term. Moreover, we quite naturally expect that net trade foreign trends may also suffer in the near–medium term as a result of the rally in the USD over recent weeks. Net trade trends are also likely to remain at the mercy of global developments, particularly in both Europe and the PRC. Elsewhere within the data, we find that there is some evidence that the Obama Administration indulged in a significant fiscal easing of its own ahead of the elections but this will likely wind down in the near term as the economy waits for the new Administration to “get up and running”, thereby implying that there may well be a fiscal drag rather than tailwind in the near term.

USA: Govt. Financial Balance USD billion