Yellen’s Dilemma

The Federal Reserve is facing a difficult year. Despite the recent strong gains in employment, household income trends remain decidedly soft and the deflation of goods prices in the retail sector has caused an evaporation of sales growth in the corporate sector, arguing that interest rates may need to remain unchanged this year.  Indeed, the current weakness in corporate profits has implied that this sector is no longer cash flow positive at an operating level which in turn suggests that weakness in CAPEX and employment trends are likely later this year.

Nevertheless, with so with foreign capital pouring into US credit markets, the boom in corporate borrowing for ‘zaitech purposes’ has continued and therefore the FRB may need to increase borrowing costs to control this latest corporate sector credit binge, although if FRB raise the interest rates then even more upward – and deflationary – pressure will be placed onto the dollar’s exchange rate.

Whatever The Federal Reserve chooses to do will likely have adverse implications in either the long or short term.   At present, we suspect the compromise outcome will likely be a probable rate rise in September if the USD has not already appreciated by another 5 – 10%, something which we suspect is quite likely to have happened.