Fed Holds Rates Steady as Trade War Rages On

The benchmark lending (or Policy) rate has been kept steady at a range of 4.25% to 4.5% ("Fed Funds Target Range"). This rate is influenced through monetary policy decisions and is used by banks to lend money overnight. It is set by the FOMC (Federal Open Market Committee).

Once set, the Fed steers the rate into the target range, through various mechanisms. 

The Fed has flagged a risk of stagflation - involving higher unemployment and higher inflation - a toxic combination. The US struggled with this in the 1970s and early 1980s; toxic because you need to prioritize which issue to address first. Paul Volcker, in his time, chose to fight inflation. The Fed has a dual mandate to manage both, and its current target is maximum employment at 2% inflation.

Treasury Secretary Yellen Hints at Higher Interest Rates

Janet Yellen, Treasury Secretary (since January 2021) and former Fed chair (2014-2018), has hinted at higher interest rates to prevent the US economy overheating.

Rick Rieder, Chief Investment Officer of Global Fixed Income at Blackrock, who joined the firm in 2009, and is a Wharton MBA, told CNBC that his "every client call...(is) talking about overheating" shortly after Yellen made her comments. Rieder oversees more than $2tr of Blackrock's $9tr AuM.

"Stabilising Inflation" Behind Russian Rate Cut to 15%

The Russian Central Bank has announced a rate cut from 17% to 15%, following which the rouble fell 2% against the dollar, making the dollar worth about 70 roubles. The IMF forecasts the Russian economy will contract by 3% in 2015 and 1% in 2016.

China Warns of Inflationary Risks of Global QE

Across Asia central banks, including PBOC Governor Zhou Xiaochuan, are expressing concerns of the inflationary risks of QE3. China has cut rates twice (June and July 2012) as growth has slowed. The RRR has been cut thrice since late 2011. To decipher the economic comments on inflation we need to be au fait with the following terms and concepts.

Core versus Headline

Headline inflation measures total inflation in the economy. Core inflation removes factors like food and energy which can experience price spikes and may thus be perceived as a more robust measure of inflation.

Relationship between Inflation and Credit

The book "An Inflation Primer" by Melchior Palyi is an interesting one with respect to bond markets. It describes the difference between inflationary and non-inflationary credit.

Investing in Inflation

It is possible to "invest" in UK inflation via the vehicle known as "index-linked gilts". These differ from "conventional" gilts in that the principal and S/A coupon payments are adjusted in line with the RPI (Retail Price Index). Gilts issued before July 2002 have their coupons calculated by the Bank of England, from July 2002 they are calculated by the UK DMO. RPI was 2.9% in August 2012.

How 3Rs Impact the Global Currency Markets

Statutory versus Voluntary Reserve Ratios

Some countries have Required Reserve Ratios (RRRs) that are statutorily enforced whilst other countries have voluntary reserve ratios.

Required reserves apply to commercial banks and usually take the form of cash or deposits made with a central bank. If a bank holds more than the required reserve, it is said to hold excess reserves.

Variation by Country

The Bank of England used to have a reserve ratio but abandoned it in the early 1980s. Canada also has no reserve ratio requirement. The US Federal Reserve has a reserve ratio that operates in tranches.

Relationship between Reserve Ratio and Inflation

The greater the reserve ratio (and correspondingly the greater the reserves held at the central bank) the less money there is for individual banks to loan, leading to lower money creation and potentially higher purchasing power of the money in circulation.

All things being equal, there is an inverse relationship between the Reserve Ratio and Inflation.

Bigger RR -> potentially lower inflation
Lower RR -> potentially higher inflation

Reserve Ratios for Inflation Control

The People's Bank of China (PBC or PBOC) alters the reserve ratio in order to control inflation. Standard Chartered anticipates a RRR cut due to "easing headline inflation" and recommends USDCNH puts. The Reserve Bank of India also controls the Cash Reserve Ratio (CRR) to control the money supply and therefore inflation.

Central Bank Slang: Near Money or Quasi Money

Reading central banking websites you will come across many unusual economic terms, such as near money or quasi-money - which refers to stuff that's not cash, but very close to cash,

They mean one and the same thing, namely highly liquid assets that can be easily converted into cash.

The IMF and World Bank do surveys of money and quasi-money in the world financial system.

Examples of quasi money would be savings accounts, money market accounts, bonds near their redemption date, government T-bills, foreign currencies (especially widely traded ones like USD, JPY and EUR).