Fed Policy : Financial Markets And The Real Economy Collide

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Fed Policy: Financial Markets and the Real Economy Collide
It has been an inauspicious start to 2016 for risky assets: equities have endured their worst first week of the year since 2000. The main trigger has been renewed weakness in the Chinese currency and equity market. Offshore yuan futures contracts indicate -10% devaluation versus the US dollar this year. Global financial conditions have tightened and there must be concern that this further stokes deflationary psychology and intensifies the growth headwinds already in place. The events in global financial markets will not have gone unnoticed by the Federal Open Market Committee (FOMC). The key issue is whether further declines in risky asset prices threaten to undermine the economic and inflation outlook. The minutes to the 15-16 December policy meeting were released last week and were widely interpreted as being dovish. It was, however, a statement by Fed Vice Chairman Fischer, who sees four increases in the federal funds target in 2016, that also put equity markets on a bearish footing. The gulf in the policy outlook between the FOMC and financial markets remains considerable: federal funds futures contracts expect the target to be 0.75% in December compared to the 1.25% forecast by policy makers. The expectations of financial markets have, however, recently been more accurate about monetary policy conduct than the forecasts of FOMC members themselves. Fed policy is data dependent and the early economic releases in

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