William De Vijlder

Group Chief Economist BNP Paribas

Fiscal and monetary policy

William De Vijlder examines fiscal and monetary policy through the lens of government and central bank decisions (including the ECB, the Federal Reserve and the Bank of England), with a special focus on changes in a country’s budget balance and public sector debt.

Fed: Avoiding the risks of stargazing

In assessing its monetary policy stance, the Fed pays attention to differences between realised and target inflation, unemployment and its natural rate, the policy rate and its neutral rate. Estimates of these reference points are highly uncertain. For this reason the Fed adopts a pragmatic approach based on data-dependence and gradualism: dovishness still prevails.

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Fed building

Fed: Market considers tightening cycle is well advanced

Recent Federal Reserve research shows that the slope of the short end of the yield curve is a more reliable indicator than the commonly used difference between 10-year and 1 or 2-year US Treasury yields. In a similar vein, we can look at the difference between the forward 3-month LIBOR rate and the spot rate. This difference has increased as of late. However, the level and shape of the entire forward curve show that the market is of the view that the Fed tightening cycle is well advanced.

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ECB: nervousness postponed

Skilful expectations management meant that the announcement of the end of the net purchases of the QE program didn’t cause any stirs. Markets have applauded the introduction of date and state dependent guidance. In the course of next year, nervousness will increase again as investors will wonder whether conditions are met to warrant a first rate hike in this cycle.

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Constraints on monetary policy push towards unconstrained investing

February’s surge in volatility, the recent dip in the eurozone’s growth momentum, the prospects of a series of US key rate hikes and of the ECB’s change of tone as it prepares to halt quantitative easing (QE) are all factors that risk intensifying arguments in favour of high conviction approaches to asset management in the months ahead: unconstrained investing makes a comeback.

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choices and decisions

US: FOMC (a)symmetries

The FOMC has an asymmetrical loss function: avoiding a recession is more important than avoiding the risk of overheating. With this comes the necessity of a symmetrical inflation objective: a temporary overshooting is acceptable. Given the unclear relationship between unemployment and inflation, the Fed’s tone remains cautious despite upbeat growth projections.

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ECB by night

ECB: predictable projections create dovish bias

Core inflation projections by the ECB have followed a surprisingly predictable path. Starting at close to but below 2% for long horizons, they decline as the remaining horizon shortens. The big difference between the projections at long horizons and the eventual outcome implies they provide little information to the market: they simple confirm the ECB’s objective. They can also introduce a dovish policy bias.

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US: playing with privilege

Fiscal reflation in a full employment economy makes it very likely that the US current account deficit will increase alongside the budget deficit. Despite rising bond yields, fuelled by the prospect of increasing budget deficits and monetary tightening, the dollar has weakened.

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US: inflation unease

After the upside surprise to hourly wages earlier this month, the consumer and producer price inflation numbers have also come in higher than expected. Anticipating inflation dynamics has become very difficult, as the Phillips curve has become less apparent. This forces investors and policy makers to pay more attention to recent data than to long-term relationships.

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