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Janet Yellen’s six month tightrope walk

The Federal Reserve’s moderation in monetary tightening is crucial to sustaining fragile global economic growth in 2016 according to a panel of financial experts at the opening session of the Credit Suisse AIT conference in Hong Kong:

“The US economy is improving, but not enough to withstand monetary tightening beyond the Federal Reserve’s quarter-point rate hike last December… Fortunately, the Fed under Chair Janet Yellen appears to have put the brakes on interest rate hikes in the near term. Tightening now could damage the US economy, not to mention the global economy. On the other hand, accommodative monetary policy creates little risk, even if it enables inflation to rise above the Fed’s 2 percent long-term target.”

These sentiments hint at the politics of Janet Yellen’s position.  Although the headline US jobs figures are good, other indicators suggest that the US may be on the verge of another recession.  Yellen – who was appointed by Obama, and would very much like to keep her job beyond November’s Presidential election – has to talk the economy up without actually doing anything that might risk a full blown crisis.

The reality is that if the US economy was as healthy as the Federal Reserve keeps claiming, and if the jobs data is as healthy as the headlines suggest, there is no reason not to raise interests again.  As periodically, the Federal Reserve has hinted it might.  In practice, Yellen was chastened by the stock market scare in January and February, which was the direct result of the decision to raise interest rates a mere quarter of one percent.  It was only the decision to suspend further rate rises that helped stabilise the situation.

Hilary Clinton – the candidate most likely to keep Yellen in post – needs the economy to be strong… even if it isn’t.  The rise of Sanders and Trump demonstrates that a large swathe of the US electorate is hostile to what they see as Washington elite candidates like Clinton and the hapless Jeb Bush.  But so long as Clinton can convince the electorate that the economy is strong, she is likely to pick up enough votes on the basis of offering business as usual.  If, on the other hand, Yellen and her Fed colleagues were to do something foolish – like carrying out their threat/promise to raise rates again, there is a real risk of a stock market crash and another financial crisis.  In those circumstances, a Trump victory becomes a real possibility.

Whatever the economic data is saying, Yellen is obliged to walk a tightrope between saying that everything is fine, while acting as if it isn’t.  And the shadow that will haunt both Clinton and Yellen in the next six months is the so-called “Black Swan”… the external event that triggers a crisis anyway.

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