Reasons to be cheerful about US growth

Markets have over-reacted to the taper and under-estimated the persistence of low inflation, says Ethan Harris, co-head of global economics at BofA Merrill.
Ethan Harris

Ethan Harris has his work cut out. The co-head of global economics at Bank of America Merrill Lynch is in Asia to help clients understand what’s going on in the US.

There is plenty to explain. People want to know who the next US Federal Reserve chair will be, when the taper will kick in and whether a sustainable economic recovery is on the horizon — not to mention the likelihood of war with Syria.

Speaking from BofA Merrill’s office in downtown Tokyo on Monday, as a typhoon swept the country, Harris was taking it all in his stride. “My message is to chill out,” he said.

“There's a lot of scepticism overseas about whether the US really is in a transition to a stronger growth phase. Our view is that we are, and that there really are fundamental reasons for optimism. It's just taking a little longer than people are hoping for.”

One of the most important points Harris is pushing is that the US and global economies will continue to experience sustained and very low inflation for the next couple of years, which means that policymakers in Asia will have plenty of flexibility to focus on growth and re-stimulate their economies.

Taper talk
More immediately, Bernanke and his colleagues need to put the tapering genie back in the bottle, prompting the Fed's surprise decision on Wednesday to delay the easing of monetary stimulus.

The negative market reaction to talk of tapering has partly been a result of the Fed’s communication strategy. Under Bernanke’s leadership, market participants have sometimes been confused by the bank’s newfound openness, which has come as a dramatic change after almost 20 years of parsing Alan Greenspan’s words to divine any hint of an interest rate signal.

Instead, Bernanke has spoken to the market like it's a grown-up, candidly admitting that the Fed was considering tapering its $85 billion-a-month asset purchases later this year, using careful guidance and targets to convince markets that the exit from quantitative easing will be slow and measured.

That strategy has not worked very well. The market responded to the Fed’s grown-up message with a panicked bond sell-off and translated “later this year” into “definitely September”.

“Every time the Fed has hinted at a move towards the exit, markets have accelerated the whole path — everyone pulls forward the date of the end of quantitative easing and the date of the first interest rate hike,” said Harris. “The Fed is on its knees begging people not to do that, which is why I like ‘no taper’ as a call — it sends an unambiguous message to the markets.”

A mini taper was the compromise option, with a cut of $10 billion to $15 billion, which most of the market had expected.

If the Fed gets it right, the US economy should start looking better during 2014, which would clearly be positive for emerging markets, and Asia in particular.

After Bernanke
Larry Summers’ exit from the race for the chairmanship of the Fed is also positive, according to Harris, who noted that markets were uncertain about the former treasury secretary.

Janet Yellen, the vice-chair and new frontrunner to succeed Bernanke, represents policy continuity and her appointment would reinforce the Fed’s dovish stance.

“When people say that Yellen's very much like Bernanke, it's not just that they both agree that quantitative easing is an effective tool for policy,” said Harris. “It's also that they agree on the communication strategy, they agree about an inflation target and they agree on a committee approach to monetary policy, so the continuity is in both substance and style.”

Like Bernanke, Yellen sees the decision to taper as a technical adjustment that is not equivalent to a decision to end QE or raise interest rates. And her focus is on growth rather than inflation.

Summers’ exit might have been a blow for Barack Obama, but everyone else should breathe a sigh of relief.


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