The Fed (and every other Fed commentator) uses the word “normalization” to describe the upcoming next phase of monetary policy. While the debate focuses on when that might be — as in, exactly how long is a “considerable period?” — we’ll simply say sooner than the markets expect. Now we can answer this question recently posed to me by a financial advisor: “What does normal mean?” “Normalization” refers to the two main components of the policy response to the 2008 financial crisis: quantitative easing (QE) and zero interest rate policy (ZIRP).
By “normalization” the Fed means returning its balance sheet to its pre-crisis size by exiting quantitative easing. That was last year’s story (the “taper tantrum”), and in the September Federal Open Market Committee meeting the Fed outlined its plans for how it intends to normalize its balance sheet. Leaving aside the many “inside baseball” details, the key implication of QE was that this policy was fundamentally directed towards reducing longer maturity interest rates. The Fed supported the housing recovery by targeting the QE programs at subsidizing mortgage borrowing costs. Hence, the exit from QE debated last year led to increases mainly in longer maturity interest rates.
“Normalization” means the end of ZIRP. This second part is more “normal” in that we can compare policy rates historically over past periods of Fed policy accommodation. Importantly, when considering the degree of policy accommodation historically, we need to look at the “real” fed funds rate (the nominal fed funds rate less the rate of inflation). Today, with inflation around 2%, current policy places rates at minus 2%.
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Nine basic facts about the American economy that you may not know, but really probably should…
1) The largest destination for U.S. goods exports is Canada.
The second largest is Mexico. China is third.
2) We import the most stuff from China.
Maybe you did know that. But Canada is second.
Typically gridlock in D.C. is bullish for the markets. Gridlock keeps any meaningful legislation from being passed and removes an uncertainty from the equation. However, if the House and Senate aren’t able to reach a deal on a government spending bill by September 30th, the federal government will shut down. At the time of this writing there had been no bill passed. The last time the Federal Government was shut down was at the end of 1995 and early 1996 when it was shut down twice for four weeks combined. The shutdown was the result of conflicts between Democratic President Bill Clinton and the Congress over funding Medicare, education, the environment and public health in the 1996 budget. The government shut down after Clinton vetoed the spending bill the Republican-controlled Congress sent him. The Federal Government put non-essential government workers on furlough and suspended non-essential services from November 14 through November 19, 1995 and from December 16, 1995 to January 6, 1996.
What Was Old is New Again
Back then, a majority of congress members and House Speaker Newt Gingrich, had promised to slow the rate of government spending, however, this conflicted with the President’s objectives for education, the environment, Medicare and public health. When President Clinton refused to cut the budget the way the Republicans wanted, Gingrich threatened to refuse to raise the debt limit (sound familiar?).
Today something very similar is happening except this time it’s mostly about “Obamacare.” Republicans want to defund the relatively recently passed healthcare legislation to keep it from ever being fully implemented. It is highly unlikely congress will allow a government shutdown, so the most likely scenario is republicans acquiesce and the government stays open. Read more »