Lombard: Fed will taper then reverse course

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TSLombard with the note:

Focus on the taper is understandable but misplaced–the Fed’simpact on this cycle will come from AIT having ended the strong dollar policy. TheFed has moved from using interest rates as needed to stabilize the dollar and sustain foreign capital inflows, to using the balance sheet to offset foreign financing inflows sufficiently to allow real rates and the dollar to fall. We set summer 2019 as the first tactical use of this policy shift, and adoption of AIT a year later a sformalization of this policy as tactic for all phases of the business cycle. The market can rest assured that taper lasts only until real rates rise because of the Fed’s absence and thus creates a “tax”on the expansion.

The Fed’s reluctance to announce a taper to begin months from now, assuming the economy behaves, is rooted in their 2018 experience when QT sharply tightened financial conditions. They need not be so concerned this time around, at least notfor2022. In 2018 the deficitdoubledjustasQTwent full bore, while in 2022 the deficit will be about $1trn less–about the Fed’s rate of purchase of US Treasurys. However fast the Fed plans to taper their pace, purchases will not be zero in 2022. With the Fed buying less and the Treasury needing less than that, financial conditions will remain easy.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.