Money Is Getting Tighter Faster Than Fed Intended
12 February 2016 - 11:40AM
Dow Jones News
By Ben Eisen
Monetary-policy makers are coming to the grim conclusion that
financial markets aren't letting them tighten financial conditions
gradually.
The problem: The rise of the dollar over the past year and the
swift retreat from risk in 2016 are raising the cost of funding and
damping growth in the real economy more quickly and extensively
than the Fed would like. The effects are significant enough that
Federal Reserve Chairwoman Janet Yellen pointed to higher borrowing
costs and the dollar in testimony before the Senate Banking
Committee on Thursday.
"Financial conditions in the United States have recently become
less supportive of growth," she said.
The Fed's goal in lifting interest rates in December was to
gently bring them back to more normal levels after keeping them
near zero since the financial crisis. The Fed has lifted its policy
rate just that one time on Ms. Yellen's watch. But some economists
track indicators to come up with a "shadow" measure of the
Fed-funds rate. That has climbed significantly since mid-2014, when
the U.S. central bank began winding down its bond buys.
To be sure, financial conditions still aren't excessively
restrictive. While the tightening, if sustained, could cut into
economic growth this year, it isn't accelerating at a pace that
suggests a coming recession, according to Capital Economics.
Still, financial conditions, based on a series of market
indicators, are as tight as they have been since the financial
crisis, according to BlackRock.
One reason is the dollar.
When U.S. dollars become more expensive, it becomes more costly
for those outside the U.S. to borrow in the currency. It also
weighs on corporate sales and profits, giving companies less money
to spend or invest. Apple Inc., for example, said last month that
overseas revenue worth $100 in the last quarter of 2014 was now
worth just $85.
The WSJ Dollar Index has dropped 2.8% in the past two weeks. But
it has climbed 20% over the last two years.
"Foreign-exchange translation will continue to be a headwind,
with most of our key international markets' currencies expected to
decline vs. the U.S. dollar in 2016," Hugh Johnston, chief
financial officer at PepsiCo Inc., said in an earnings call
Thursday.
The cost of borrowing in the credit markets has also gone
up.
Bonds issued by companies with bottom-of-the-barrel triple-C
ratings are trading at yields that are roughly 15.66 percentage
points above U.S. Treasurys, compared with 13.51 points at the end
of the year, according to Barclays, which maintains closely
followed bond indexes.
Spreads on investment-grade triple-B bonds are now at yields
that are 2.76 points above Treasurys, compared with 2.2 points at
the end of 2015.
Equity financing is getting more expensive, too.
As the S&P 500 Index has fallen 10.5% so far this year, only
two companies have gone through with initial public offerings--the
lowest number since 2009.
Some market observers have suggested that if conditions get too
tight, the Fed will need to back off its path of ratcheting up its
policy rate, move in the opposite direction or even consider
cutting its own key rates below zero.
"I don't know that markets really start changing their tone
until the Fed convincingly walks back from the idea of further
tightening or even a reversal," said Sam Garza, a portfolio manager
at DoubleLine Capital, which manages $85 billion.
Markets have moved against central banks outside the U.S., too.
In the past month, the euro and yen have each risen nearly 5%
against the dollar, when the European Central Bank and Bank of
Japan would prefer them to weaken.
Mike Cherney contributed to this article.
(END) Dow Jones Newswires
February 11, 2016 19:25 ET (00:25 GMT)
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