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The Economist December 16th 2017 Finance and economics 65
2 Goodfriend has for years called for higher leagues may test Mr Powell’s commitment tuallyriseby0.4percentagepoints. The bill
rates, prematurely sounding the alarm to continuingMs Yellen’s approach. that passed the Senate on December 2nd
about inflation as early as 2010. In 2012 he The Fed must also decide how to re- would raise deficits by 0.2% ofGDP in 2018
described as“doubtful” the notion that the spond to Mr Trump’s tax cuts. Even if the and1.1% of GDP in 2019, not counting its ef-
Fed could bring unemployment down to economyisnotontheedgeofoverheating, fect on workand investment incentives.
7%. When Ms Yellen departs, Mr Trump thesearepoorlytimed.Werestimuluswar- Policymakers in recent years have tend-
will have another three seats to fill. More- ranted now, the Fed could always cut rates, ed to show too much caution, rather than
over, voting rights rotate among regional avoiding the higher public debt that fiscal too little. That is why a full recovery from
Fed presidents, whom the president does stimulus incurs. Tax cuts might spur some the financial crisis has taken so long; it is in
not pick. Three doves—Charles Evans from investment and raise growth by a few part why inflation is too low today. It
Chicago, Neel Kashkari from Minneapolis, tenths of a percentage point in the short seems likelier that they will err on the side
and Robert Kaplan from Dallas—will lose term. But they are also likely to nudge the of caution than allow the economy to run
their votes in January, to be replaced by Fed towards faster rate rises. The central toohot.ButAmerica’spolicydebate isfine-
more hawkish voices. A fourth dove, Mr bank’s economic model suggests that for ly poised. As the economy approaches its
Dudley, plans to retire in 2018. His new col- every1% ofGDP in taxcuts, rates will even- capacity, the margin forerrorshrinks. 7

Buttonwood Swanning about

The marketviewofBrexitis more complexthan itappears
OR all the sound and fury ofthe Brexit markets, the Brexit effect has to be seen in 26% in the S&P 500, America’s main
Fnegotiations, it has seemed at times as lightofglobaltrends:historicallylowbond benchmark(see chart). In both dollar and
if the financial markets have been barely yields and a widespread stockmarket sterling terms, the FTSE 100 index has
affected. But as with the swans that glide boom. Ten-year gilt yields fell below 1% in been one of the worst-performing devel-
on the Thames, a serene surface conceals the aftermath of the referendum, and are oped markets in 2017. A survey of global
some frantic paddlingunderneath. still below their level at the end of May fund managers by Bank of America Mer-
The pound is the most reliable indica- 2016. But bond yields can drop for two rea- rill Lynch in November found that a net
tor of the Brexit mood. A rule of thumb is sons. The optimistic one is that the bonds 37% have a lower-than-normal weighting
that, if the headlines point to a “hard” look more attractive to investors, so the in British equities.
Brexit (creating trade barriers with the price risesand the yield falls. The pessimis- Nevertheless, there has been no dra-
EU), sterling will fall; signs of a “soft” tic one is that investors become less san- matic stockmarket sell-off and the pound
Brexit (something that is close to the cur- guine about the economic outlook and is above its post-referendum lows. Inves-
rent relationship) will cause it to rise. shift into bonds because they are less risky. tors have tended to ignore the nationalist
But some feedback processes are at It is tempting to assume the pessimists rhetoric and assume that rationality will
work. The big fall in the pound in the im- are wrong; after all, the stockmarket is up triumph in the end. The trading links be-
mediate aftermath ofthe referendum has and it would suffer if economic growth tween Britain and the EU are too impor-
led to a gradual rise in imported inflation. were thought to be at risk. But the analysis tant to jeopardise. Furthermore, the pro-
The annual inflation rate hit 3.1% in No- is made more complicated by the presence cess has become elongated. Since a
vember, requiringMarkCarney, governor ofalotofmultinationalsintheFTSE100in- two-year transition deal seems likely, the
of the Bank of England, to write to Philip dex. Their prospects are not wholly reliant crunch pointfortrade maynotoccur until
Hammond, the chancellor, to explain on the British economy. And theiroverseas 2021. As a result, investors choosing how
why the target (of 2%) had been missed. earnings are worth more, in sterling terms, to allocate assets in 2018 may decide not
The bank has already raised interest rates afterthe pound’s fall. to worry about Brexit too much.
once. More rises may follow, and expecta- In relative terms, British equities have One school of thought is that the pro-
tion ofsuch rises supports the pound. not been performing well. Measured in cess will turn into BINO (Brexit In Name
The need for monetary tightening is dollar terms, the FTSE 100 has risen by just Only) with Britain staying in the single
not simply a result ofhigher import costs, 6% since the referendum, compared with market—in effect, remaining in the EU but
which might prove temporary. More wor- gains of 23% in the MSCI World index and without having any influence over the
ryingly, the Bankthinks that the trend rate rule-making process. That is the logical
ofgrowth ofthe British economy has fall- consequence of the deal that has been
en (a view it shares with the Office for Sunlit uplands reached over the Irish border; ifNorthern
Budget Responsibility, the government’s Share prices, $ terms, June 23rd 2016=100 Ireland stays aligned both with the regu-
forecasting arm). In part, this is because lationsprevailingin the Irish republic and
130
Britain faces a more difficult future after in the rest of Britain, the implication is
Brexit; in part it is a recognition that the 120 that Britain stays in the single market.
economy’s productivity was dented by S&P 500 MSCI But that also leaves scope for disap-
World
the 2008 financial crisis. 110 pointment among investors later, when
If the trend growth rate falls, that the British government tries to reconcile
brings forward the time when a tighter la- 100 the various contradictory promises it has
bour market begins to be translated into FTSE 100 90 made. That is another thing with swans;
faster wage increases and into broader in- they lookbeautiful, but they are bad-tem-
flation. In turn, this means the central 80 pered birds which can give a nasty whack
bank may have to act more quickly to JJ A S O N D JF M A M J J A S O N D with theirwings.
2017
2016
push up interest rates. Source: Thomson Reuters
When it comes to the bond and equity Economist.com/blogs/buttonwood