March 27, 2023
Fed Moves - Flexport Weekly Economic Report
Normally, a hike in the Fed Funds rate represents a tightening of monetary policy. We had a 25 basis point (bp) hike this week, but complicating factors in the transmission mechanisms mean the net effect on the economy is yet uncertain.
In Focus - Fed Rates and Assets
This past week the Fed raised its target interest rate by 25 bp to 4.75-5.00% (the red line on the chart and the right-hand scale). This was the latest move in 12 months of very rapid escalation in the Fed Funds rate. In so doing, the Fed moved in the same direction, if not at the same speed, as the European Central Bank (50bp) and the Bank of England (25bp).
In each case, the expressed rationale was the same: inflation persists at levels higher than the central banks find acceptable.
In a textbook description, an increase in the very short-term rate controlled by the U.S. Federal Reserve should prompt banks and bond markets to raise the lending rates that are more directly relevant to economic activity. This, in turn, would slow economic activity and aggregate demand and thus diminish inflationary pressures.
But these are complicated times; the details of this transmission mechanism matter. We’ll take a quick look at three important parts and consider whether U.S. monetary policy may end up looser or tighter than intended.
First, we look at Federal Reserve assets. These are depicted in the black line in the chart (left-hand scale). On the eve of the pandemic, Fed assets were just above $4 trillion. In response to the shock, the Fed lowered the Fed Funds rate to zero and then engaged in ‘quantitative easing,’ pumping money into the economy by buying bonds. These bonds end up as Fed assets. The balance sheet ultimately swelled to just under $9 trillion, peaking in mid-April 2022.
Just as quantitative easing puts money into the economy and loosens monetary policy, quantitative tightening sells assets and does the reverse. From last April to the beginning of this month, the Fed shrank its balance sheet by $626bn. How do the effects of that compare to those of a rate hike? We don’t really know. There are estimates, but this is not a maneuver with which we have much experience.
Further complicating matters, a substantial amount of the year’s quantitative tightening was reversed in the past two weeks, when assets rebounded by $394bn. Amidst growing concern about the banking sector, banks have been borrowing heavily and unusually from the Federal Reserve. These loans end up as assets for the Fed. The recent moves here, then, mitigate the tightening.
A second transmission factor involves the behavior of the banking sector. The textbook also presumes that banks are equally willing to lend, just at higher rates. If banks become less willing to lend among concern about withdrawal of deposits, that would count as additional tightening. This factor is very hard to quantify.
A final transmission factor involves the behavior of longer-term rates, such as the benchmark 10-year Treasury bond. On March 2 the yield was 4.08%. By the close of last week, it had fallen to 3.38%, a dramatic drop. This likely indicates market skepticism about Fed pledges to keep rates higher for longer. Lower long-term rates are likely to stimulate the economy, the opposite of the Fed’s intent and a potential spur to further inflation.
It is clear that the Fed raised rates this past week. The net effect on the economy is anything but.
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Latest Flexport Metrics & Research
This past week we launched our latest indicator - the Trade Price Forecast (TPF) which tracks how import and export prices for goods could change in the current six month period.
From last week: U.S. Auto Imports: The Road(s) less Traveled. We look at the issues facing the U.S. auto industry.
Euro area exports of goods rose 18% year-on-year in 2022 to €2.9 trillion while imports were up 37.7% to €3.2 trillion. Imports from the U.S. were up 30.6% for the year and were down 7.3% and 56.3%, respectively, from China and Russia. Preliminary estimates for January trade showed continuing growth, with total goods exports increasing 11.0% year-on-year and imports increasing by 9.7%.
Economic sentiment in the Euro area fell by 19.7 points in March from the previous month, a much sharper drop than expected, though at 10.0, it remains in positive territory. The decline ended a streak of five consecutive months of improving sentiment. Growing concern about the strength of the financial system was among the main causes for the drop.
The seasonally-adjusted value of UK retail sales, excluding gasoline, were up 2.2% month-on-month and by 6.3% year-on-year in February. In volume terms, however, the results were less positive, at 1.5% and -3.3%, respectively.
Core-core inflation in Japan, a measure that strips out energy and food but retains alcoholic beverages, increased faster than it has in the past 41 years in February, coming in at 3.5%. Earlier in the month, labor unions won a 5.28% rise in wages during the annual Shunto round of spring negotiations amidst rising inflation expectations and a tightening job market. Kazuo Ueda – from April, the next governor of the Bank of Japan – has called for ‘creative’ monetary policy.
U.S. existing home sales were up 14.5% at a seasonally-adjusted annual rate in February, the largest monthly percentage increase since July 2020 and ending 12 consecutive months of declines. The annualized rate increased from 4 million in January to 4.58 million. Meanwhile, mortgage rates, as measured by the 30-year FRM, decreased 0.18% to 6.52% from the previous week, but remain 2.0% higher than the same time last year.
U.S. current account figures for Q4 2022 and the full year showed seasonally-adjusted goods imports down 3.4% quarter-on-quarter but still up 14.9% year-on-year. The largest quarterly declines were in Industrial supplies (-8.3%) and consumer goods ex-food and autos (-6.5%). Exports also fell quarter-on-quarter (-5.7%), led by a 9.4% decline in industrial goods.
The Bank of England raised interest rates 25bps to 4.25% following the Fed decision to raise at the same rate (see essay above). The bank also noted that it revised its February forecast for Q2 GDP from -0.4% to a ‘slight increase’ and its forecast for the CPI to ‘fall significantly’ in the quarter.
USTR Katherine Tai faced questioning last week from the Senate Finance Committee and House Ways and Means Committee over concerns that the Biden Administration’s trade policy is bypassing constitutionally-mandated congressional approval for new agreements. Members on both sides took issue with ongoing negotiations for the Indo-Pacific Economic Framework, among other trade initiatives, none of which include market access (tariff reductions). The prospective ‘critical minerals’ agreements with the EU and Japan were also atop the agenda.
The IMF extended a roughly $3 billion funding facility to Sri Lanka last week to ‘restore [its] macroeconomic stability and debt sustainability.” Sri Lanka entered into default for the first time in the country’s history last year and was being watched closely for signs of a potentially wider sovereign debt crisis.
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