In a note to clients, Paul Mortimer-Lee and Bricklin Dwyer of BNP Paribas suggest the Fed has “delivered a very rapid tightening in financial and monetary conditions,” and they have dubbed this the “Great Monetary Tightening.”
The duo says while the Janet Yellen-led Fed has increased its federal funds rate by only 25 basis points, the “shadow” federal funds rate, or “the rate that, using past relationships, would be consistent with the level and shape of rates seen in the rest of the curve” has actually tightened by more than 300 basis points since May 2014. BNP says this equates to more tightening than the 1994 cycle.
This so-called very rapid tightening of conditions was the result of three things, according to BNP:
- The Fed tapering its quantitative-easing program.
- The completion of Fed asset purchases.
- Switching the Fed’s forward guidance to data dependent from date dependent.
The tightening of conditions has been accompanied by a 25% rally in the broad trade-weighted dollar, which although does have its benefits, like making US imports cheaper, has wreaked havoc for multinational American companies by making exports more expensive and by reducing overseas sales as they are converted back to dollars.
Iconic US brands like Ford, Johnson & Johnson, Proctor & Gamble, and Walmart are among those to blame the strong dollar for recent poor performance.
BNP calculates its own financial and monetary-conditions index, and says conditions have “tightened from 1.8 standard deviations below average in August 2014 to about-average today.” The investment bank takes issue with the Fed, suggesting policy remains “accommodative,” and it believes the tightening of conditions has been “too sharp.”
As a result, the turmoil in the markets is not surprising. The S&P 500 has fallen 9% from its November peak and is off 6% so far this year.
As for what to expect going forward, BNP thinks a slowdown is coming, but not until 2017. That’s when we should expect subpar growth of 1.5%. “In light of this, no further tightening of fed funds is warranted this year or next,” BNP says.
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