Follow Paul Donovan

Two reasons to tighten

| Posted by: Paul Donovan | Tags: Paul Donovan

  • Why should the US Fed tighten rates today? One reason is the economy. The Fed's policy actions influence inflation out to 2020. The Fed is trying to keep inflation stable, not lower it. Economic growth is slowing, but to a trend level. Wage pressures are rising. Zero or negative real rates are wrong.
  • More controversially, politics support a rate increase. Low, stable inflation is an economic triumph. Politically independent central banks made that happen. Markets do not want a return to the 1970s. To fail to hike may raise fears that politics is influencing the Fed. Markets would not like that.
  • The Fed did not accelerate rate increases when equities rallied and corporate tax cuts transferred wealth from the government to US listed companies (and thus did not signal future economic growth). Recent equity weakness is in large part because trade taxes transfer wealth from US companies to the government. That does not signal much about future growth.
  • Italy is having a Macron moment (breaking fiscal rules have no repercussions). Media reports suggest a deal with the EU over the budget. The UK government might face a vote of confidence (probably next year) and UK inflation numbers are due.