Fed Officials Plan to Shrink The Balance Sheet by $95 Billion A Month, Meeting Minutes Indicate

Central Bank

Summary:

Fed officials reached consensus at their March meeting that they would begin reducing the central bank balance sheet by $95 billion a month, likely beginning in May.

Fed Officials Plan to Shrink The Balance Sheet by $95 Billion A Month, Meeting Minutes Indicate_1

Federal Reserve officials discussed how they want to reduce their trillions in bond holdings at the March meeting, with a consensus around $95 billion a month, minutes released Wednesday showed.

Officials "generally agreed" that a maximum of $60 billion in Treasurys and $35 billion in mortgage-backed securities would be allowed to roll off, phased in over three months and likely starting in May. That total would be about double the rate of the last effort, from 2017-19, and represent part of a historic switch from ultra-easy monetary policy.

In addition to the balance sheet talk, officials also discussed the pace of interest rate hikes ahead, with members leaning toward more aggressive moves.

At the March 15-16 meeting, the Fed approved its first interest rate increase in more than three years. The 25 basis point rise— a quarter percentage point — lifted the benchmark short-term borrowing rate from the near-zero level where it had been since March 2020.

The minutes, though, pointed to potential rate hikes of 50 basis points at upcoming meetings, a level consistent with market pricing for the May vote. In fact, there was considerable sentiment to go higher last month. Uncertainty over the war in Ukraine deterred some officials from going with a 50 basis point move in March.

“Many participants noted that one or more 50 basis point increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified,” the minutes said.

Stocks fell following the Fed release while government bond yields held higher. However, the market came well off its lows as traders adjusted to the central bank's new posture.

The minutes were “a warning to anyone who thinks that the Fed is going to be more dovish in their fight against inflation,” said Quincy Krosby, chief equity strategist at LPL Financial. “Their message is, ‘You're wrong.'”

Indeed, policymakers in recent days have grown increasingly strident in their views about taming inflation.

Governor Lael Brainard said Tuesday that bringing prices down will require a combination of steady hikes plus aggressive balance sheet reduction. Markets expect the Fed to increase rates a total of 250 basis points this year. The minutes noted, that, “All participants indicated their strong commitment and determination to take the measures necessary to restore price stability.”

Krosby said the policymakers' position thus shouldn't have come as much of a surprise.

“The Fed orchestrated a concerted effort to warn the market, telling the market in no uncertain terms that this is serious, this is paramount, we are going to fight inflation,” she said. “What they have on their side is a still-healthy jobs market, and that's important. What you don't want is the Fed making a policy error.”

The central bank's relative hawkishness extended to the balance sheet talk. Some members wanted no caps on the amount of the monthly runoff, while others said they were good with “relatively high” limits.

The balance sheet rundown will see the Fed allowing a capped level of proceeds from maturing securities to roll off each month while reinvesting the rest. Holdings of shorter-term Treasury bills would be targeted as they are “highly valued as safe and liquid assets by the private sector.”

While officials did not make any formal votes, the minutes indicated that members agreed the process could start in May.

Whether the runoff actually will hit $95 billion, however, is still in question. MBS demand is muted now with refinancing activity low and mortgage rates rising past 5% for a 30-year loan. Officials acknowledged that passive runoff of mortgages likely may not be sufficient, with outright sales to be considered “after balance sheet runoff was well under way.”

Also at the meeting, Fed officials sharply raised their inflation outlook and lowered their economic growth expectations. Surging inflation is the driving factor behind the central bank tightening.

Markets were looking to the minutes release for details about where monetary policy heads from here. Specifically, Fed Chairman Jerome Powell said at his post-meeting news conference that minutes would provide details on the thinking about balance sheet reduction.

The Fed expanded its holdings to about $9 trillion, or more than double, during monthly bond purchases in the wake of the pandemic crisis. Those purchases ended only a month ago, despite evidence of roaring inflation higher than anything the U.S. had seen since the early 1980s, a surge that then-Fed Chairman Paul Volcker quelled by dragging the economy into a recession.

Source：CNBC

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Damon

Seven straight quarters of gains for global stocks came to an abrupt end in early 2022. The MSCI World Index fell by 4.6% in local currency terms, but recovered all its losses since the invasion by quarter-end. Markets in Australia, the UK and Japan held up relatively well, while Europe, emerging markets and China underperformed.

Equity Outlook: War Intensifies Inflation Test for Investors_1

Market declines weren't only driven by the war. Early in the quarter, expensive technology shares sold off, particularly in the US, as these stocks are more vulnerable to rising interest rates. Investors also worried that tightening monetary policy could jeopardize the world's recovery from the pandemic. And Chinese stocks were extremely volatile on concerns about regulation of internet giants, property market default risk and a COVID-19 outbreak.

Sector performance was mixed (Display, below left). Energy stocks surged while tech and consumer-discretionary shares tumbled. Defensive sectors such as utilities and healthcare were relatively resilient. Value stocks, which tend to benefit from rising interest rates, outperformed growth stocks by a wide margin (Display, below right).

Equity Outlook: War Intensifies Inflation Test for Investors_2

Putting Volatility in Perspective

Volatility surged, then eased. The MSCI World rose or fell by at least 1% on 26 trading days during the first quarter (Display, below left). Still, even as the VIX index of US equity market volatility jumped, it didn't come close to levels seen during the pandemic sell-off in early 2020 (Display, below right). In a surprisingly fast change of sentiment, the VIX fell back toward its long-term average by quarter-end, suggesting that investor anxiety diminished significantly.

Equity Outlook: War Intensifies Inflation Test for Investors_3

Since the February 24 invasion, volatility has been driven by three factors. First, risk aversion rose as investors were shocked by Europe's first major war since World War II and the spiraling humanitarian tragedy. As civilian casualties increased and more than 4 million refugees fled Ukraine, fears mounted of a direct military conflict between Russia and NATO countries—and the terrifying prospect of a nuclear exchange.

Second, severe sanctions on Russia led to the removal of Russian stocks from MSCI indices, wiping out holdings for some investors, particularly in emerging-market portfolios. Third, the conflict manifested itself in markets via disruptions to Russian and Ukrainian exports of commodities such as oil, gas and wheat. This fueled inflationary forces that threatened to tip economies into recession, or worse, stagflation—a painful combination of a growth stagnation and rising prices. Supply-chain concerns emanating from China's COVID-19 situation augmented these risks.

Inflation Will Be Sticky

Inflationary forces were already brewing at the beginning of 2022. In recent years, the deflationary forces of globalization have been under pressure. Populist trends, from Brexit in the UK to the US-China trade war, prompted countries and companies to rethink global supply chains. Then, the pandemic led to widespread supply disruptions and central banks implemented historically loose monetary policies.

The Russia-Ukraine war has exacerbated these pressures. Even if some war-related disruptions are resolved, countries and companies are seeking new ways to source essential inputs, from oil and gas to auto components, microchips and food ingredients. Localizing sources of supply will keep prices higher because it means companies aren't necessarily producing raw materials and components in the most cost-effective locations. And demand for more local staff is likely to continue pushing up wages, especially as employees are leaving their jobs in record numbers, in what has become known as the Great Resignation. Now it's clear that inflation will be sticky.

Consumer price inflation in the US reached an annualized rate of 7.9% in February, a 40-year high. Eurozone inflation jumped to 5.8% in February, while UK inflation surged to a 30-year record of 6.2%. Even in Japan, which has battled deflationary pressures for years, consumer price inflation might approach the central bank's target of 2% this year.

Supply Shock Creates New Challenges

Since inflation today is being driven by a supply shock, the challenges are very different than inflationary bouts in the recent past. Central banks have a monumental task. In the US, the Fed began raising interest rates in the first quarter and has shifted to a more hawkish stance. The European Central Bank has also moved to tighten monetary policy, but the region faces greater risks to growth because consumers are in a much weaker position. Given the complex forces fueling inflation, central banks must be very flexible to ensure their policy actions don't undermine growth.

Managing inflation while maintaining growth will be very tricky. Today's inflation is pervasive, infecting many products and industries across the globe. Its myriad sources go well beyond traditional shortages to include geopolitical frictions, a retreat from globalization and changing preferences of the workforce. New sources and supply chains need to be established, and the traditional approach of raising interest rates to stifle demand may be less effective.

Even if inflation cools, we believe it's likely to remain higher than we've been accustomed to for many years. In this new world, we believe equity investors must apply a strategic view of inflationary trends to fundamental analysis. That involves understanding the relationship between inflation, earnings and returns, figuring out the micro impacts on industries and companies, and developing investing criteria according to different portfolio philosophies and processes.

From Earnings Growth to Profitability Squeeze

Higher prices add hurdles for companies. While inflation often boosts revenues, a company's nominal profits must grow fast to stay ahead of rising costs. At moderate inflation levels, earnings tend to outpace prices. Our research shows when inflation was between 2% and 4% per year, US companies delivered real earnings growth of about 8.8% per year since 1965. We've observed similar trends for global companies over a shorter time span.

But can companies maintain earnings growth in the environment we're facing? Measures of profitability point to the challenges. Today, global net income margins are extremely high (Display), implying that profitability is ripe for a reversal. The combination of high margins, slowing growth and input cost pressure will squeeze profitability for many companies, in our view. Equity investors must find companies that can maintain margins should these conditions persist.

Equity Outlook: War Intensifies Inflation Test for Investors_4

We believe this will be a key differentiator of long-term equity return potential in the new inflationary world. Our research also indicates that the dispersion of returns tends to be wider during periods of higher inflation. A wider dispersion usually provides active managers with attractive opportunities to find companies with better return potential.

To do so, investors must identify the microeconomic impacts of inflation that affect business outlooks, cash-flow potential and future returns. Across industries and markets, two key questions can help frame the analysis.

How are input costs evolving? Many companies that are meeting revenue expectations are facing earnings downgrades because of rising costs. Those that can substitute cheaper input sources will have an advantage in maintaining margins as prices rise. Companies capable of restructuring manufacturing processes and supply chains will also be better placed to preserve profitability.

Does the company have pricing power? Pricing power is always an important indicator of a quality business, but even more when inflation runs high. Look for conservative companies that don't make sharp shifts in guidance. Consistency of recent profit margins is another good sign of pricing power. Companies with long-term secular catalysts for their business, such as environmental efforts or technological adoption, are also better equipped to push prices higher without sacrificing demand.

Quality Features for Evolving Risks

These questions can guide active portfolio managers to the right companies for the new regime. Since most of the asset-management industry's quantitative models were developed after the high inflation of the 1970s, they're designed for a deflationary regime and might not provide reliable indicators for the future. And because the effects of inflation on companies are complex, we believe comprehensive fundamental analysis that emphasizes high-quality features is essential to find companies that will endure tougher conditions.

Growth portfolios, for example, should be wary of companies that still look overvalued after the recent sell-off, while targeting those with sustainable growth drivers that can withstand a tougher macroeconomic environment. Value stocks historically have performed better when interest rates rose. However, we believe companies with higher-quality cash flows and balance sheets, and clear catalysts for recovery, are preferable to the cheapest names with inferior fundamentals.

As the new quarter begins, the mood in markets has calmed somewhat. But risks abound, from a Russian debt default to China's growth to the global economy's fragility. While the market has stabilized after the initial war shock, be prepared for more volatility as fallout from the conflict ripples through the global trade system. With a disciplined approach to company fundamentals that puts inflationary threats and opportunities front and center, we believe investors can gain confidence in positioning for the complex times ahead.

Source：ALLIANCEBERNSTEIN

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Devin

Russia-Ukraine Conflict

Mere months ago Turkish President Recep Tayyip Erdogan was on the ropes. The lira had crashed and his unorthodox monetary policy was being ridiculed in financial markets.

But the Russian invasion of Ukraine, and its subsequent struggles on the battlefield, have led to a dramatic diplomatic turnaround for Turkey, which finds itself at the center of efforts to establish a cease-fire.

It stands in contrast to China and India, who have been criticized by the global community for sitting on the fence. Unlike Beijing and New Delhi, Ankara was quick to express support for Ukraine and condemn Russia's invasion. But Turkey has not joined international sanctions on Russia, continues to allow Russian aircraft to fly through its airspace and is offering its ports to Russian oligarchs to moor their superyachts.

Yet far from being slammed Turkey is being commended for its actions and, as a byproduct, a number of its diplomatic headaches are being cured.

"Efforts to isolate Turkey in the Eastern Mediterranean have vaporized," Burhanettin Duran, the general coordinator of Ankara-based think tank SETA Foundation, told Nikkei Asia. Regional rivals Israel, Greece and Cyprus have been planning an EastMed gas pipeline to deliver Mediterranean natural gas to Europe, intentionally bypassing Turkey.

That project fell into limbo after the Biden administration in January signaled it does not support it. The announcement was widely seen as a nod to Turkey, whose help the U.S. needs in Ukraine.

In recent weeks, Israeli President Isaac Herzog and Greek Prime Minister Kyriakos Mitsotakis have visited Turkey to deepen engagement.

"Turkey's importance in securing stability and security in its surrounding region and its importance in the regional power equation has been rediscovered," said Duran, who also sits on the Turkish Presidency Security and Foreign Policies Council.

European countries will need to adjust their "strategic compasses" to reflect the new reality, Duran said.

The U.S. might have been a step ahead in realizing Turkey's significance. "From around the end of last year, Washington began to focus on Turkey's importance, based on the premise that Russia will take action on Ukraine," said Satoshi Ikeuchi, a professor at the University of Tokyo.

Until that point, U.S. President Joe Biden had not put Turkey high on his list of priorities. He did not call Erdogan until three months into his term. The first call was to inform the Turkish leader that Washington was going to designate the 1915 demise of Armenians during the Ottoman era as "genocide."

But on Nov. 19, Biden's national security adviser Jake Sullivan called his Turkish counterpart Ibrahim Kalin to discuss Ukraine. "The Biden administration is extremely concerned about the Russian buildup in the Donbas region," a Turkish source familiar with the discussion said of the call. "They said they have 'evidence' that Russia might start something. We have our own assessments and our concerns and Sullivan wanted to exchange information."

That timeline matches what Ikeuchi is saying. "The U.S. objection to the EastMed project was a clear signal that it was prioritizing relations with Turkey," the University of Tokyo professor said. "Washington understood that Turkey had favorable conditions when it came to Russia, first and foremost in the Bosporus and the Dardanelles Straits."

Together known as the Turkish Straits, the narrow waterway that runs through the Turkish cities of Istanbul and Canakkale constitutes the only gateway in and out of the Black Sea. The Montreux Convention of 1936 gives Turkey the right to close off the waterway in times of war.

If Russia needed to bring naval vessels from other ports, such as the Baltic Fleet in Kaliningrad or the Pacific Fleet near Vladivostok, it would need Turkey's green light to enter the Black Sea to assist the Black Sea Fleet in Sevastopol, the largest city of the Russian-annexed Crimean Peninsula.

"There is no other large-scale chokepoint like this in the world," Ikeuchi said. "Furthermore, Turkey has the legal basis to control it. Russia cannot alter that status quo with force, and Moscow has to respect Turkey's leverage."

Turkey's other edge is its military collaboration with Ukraine. The impact of the Turkish-made Bayraktar TB2 attack drones, sold to Ukraine, has been well documented. However, according to a European diplomat in Ankara, Turkey is discreetly supplying other defense products to Ukraine as well.

Aleksei Erkhov, Russia's ambassador to Ankara, told local media this week: "Let me be honest, You cannot imagine how these [drone] shipments are received with pain by Russian society. It is not perceived with understanding based on statements like 'business is business' as your UAVs are killing our soldiers."

But the partnership extends further, including R&D and co-production of various assets.

The collaboration deepened after Turkey faced explicit and implicit export embargoes by its NATO allies for purchasing S-400 missile-defense systems from Russia. Ukraine has not only become a customer of Turkey's drones and corvette warships, but also a supplier of key technologies, such as the drone engines, which Turkey lacks.

Current versions of Turkey's next generation armed drone Akinci, by the producer of TB2, with 10-times more total payload capacity, is flying with Ukraine made engines.

"Turkey's careful balancing -- the only NATO country that both has sympathy and empathy for the Russians and the ability to thwart them militarily on several fronts -- has positioned them uniquely," said geopolitical consultant Rich Outzen, a retired U.S. military officer and State Department policy planner.

Turkey is "not afraid to commit to a friend in need, yet careful not to overreach or anathematize the opponent," Outzen said.

Such a balancing act can only be carried out for so long. Soner Cagaptay, director of the Turkish Research Program at the Washington Institute for Near East Policy, said the reason Erdogan is trying so hard to mediate between Russia and Ukraine is that if the war is prolonged, he might be forced to make a clearer choice between Russia and the U.S.

"If there is an amphibious attack on Odesa and Russia wants to bring other ships into the Black Sea, Erdogan would come to the point where he has to keep the Bosporus closed to naval vessels, because that is demanded by the Montreux Convention. But he can't because that would rupture ties with Putin."

Duran also sees the risk that Russia may not remain silent if the Turkish Straits remain closed much longer. "If the war prolongs and Russia's supply in the Eastern Mediterranean is jeopardized, we will see how things go," he said. "But prolonging the Ukraine war is also not in the interest of Russia, so at least with a cease-fire, they will try to de-escalate."

While Turkey has had geopolitical gains, whether they will be enough to help Erdogan win reelection next year is another question.

"This could not have happened at a worse time for Erdogan because he was relying on strong tourism and trade with Russia to open up the economy strongly," Cagaptay said. "Erdogan was also relying on good ties with Biden in order to create an image that Turkey is good for investment and markets will start investing in Turkey again."

After this war, playing nice with the U.S. and Russia may prove to be more difficult.

Source: Nikkei Asia.

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Samantha Luan

Due to factors such as low vaccination rates, developing countries are already slower than developed countries to recover after the pandemic. Higher global energy and food prices in the wake of the Russia-Ukraine conflict and a tighter financial environment due to interest rate hikes in developed economies will aggravate the difficulties of developing countries.

While the damage caused to countries by the COVID-19 pandemic is "reversible because domestic policies can deal with it," the challenges posed by the Russia-Ukraine conflict are "out of the control of domestic policymakers, which could have irreversible impacts."

1. Important Economic Setbacks in Emerging Markets

1.1 Soaring food prices

Russia and Ukraine are an important global "breadbasket." Compared to the average price in January 2022, the prices of wheat and corn exported from Russia surged by almost 90% and 50%, respectively, on March 15.

This is also a more severe inflationary pressure for developing countries with a higher share of food and energy expenditures. Due to food and energy price increases, inflation in emerging markets is expected to rise by 0.5 to 1.0 percentage points. And global food prices already rose 23.1% in 2021, the highest increase in a decade, according to the U.N. Food and Agriculture Organization.

According to United Nations Conference on Trade and Development (UNCTAD) statistics, MENA countries like Turkey and Egypt are highly dependent on wheat from Russia and Ukraine. These countries have been paying food subsidies to their citizens, and soaring food prices will increase their financial vulnerability, which was already overwhelmed during the pandemic. The challenge of "de-globalization" is even greater for developing countries with "large young populations for whom jobs need to be created."

1.2 Supply chain affected

Southeast Asian countries have struggled in recent years to become part of the global supply chain, but the COVID-19 pandemic has slowed down the process, and the Russia-Ukraine conflict will aggregate the volatility of the global supply chain, which will also be affected by the future decline in demand from Europe and the U.S.

According to the latest institution report, the EU accounts for 9% of the export markets of the ten ASEAN countries, with over 11% of exports from Vietnam and the Philippines destined for the EU.

1.3 Tourism is in a slump.

(FDI) also comes from the EU. It is generally believed that the European economy may slip to the brink of recession due to the Russia-Ukraine conflict, which will have a negative impact on ASEAN's exports.

Southeast Asia was popular with tourists from Europe, China, and Russia before the pandemic. Europeans accounted for 17% of overseas visitors to Thailand, 13% to Indonesia, and 11% to Singapore. After a two-year downturn in the tourism sector, most Southeast Asian countries are preparing to lift most entry restrictions this spring to welcome foreign tourists again, but the Russia-Ukraine war could set back Southeast Asian tourism again. So far, Russian tourists have canceled their travel plans because of the devaluation of the local currency, the ruble, flight suspensions, and difficulties in transferring money across borders.

2. Financial Tsunami Impacts due to the U.S. Interest Rate Hike

The conflict between Russia and Ukraine has caused inflation to continue to rise. The Fed has announced interest rate hikes. For many emerging markets, the tightening of the financial environment will be a huge impact, especially for low-income countries in debt distress. We are worried that the conflict between Russia and Ukraine will lead to an increase in the uncertainty in the international capital market, a decrease in global demand, inadequate policy coordination at the international level, and an increase in the debt level caused by the pandemic. Together, these factors will result in financial shock waves, pushing some developing countries into a situation of debt default, economic recession, and stagnant development. For those least developed countries and middle-income countries, the volatility of global capital flows and exchange rates, rising borrowing costs, and the risk of serious external debt payment difficulties are particularly challenging.

According to the World Bank, about 40 low-income countries around the world are already in debt distress or at risk of debt distress because of the pandemic impact. Some of the countries with the largest ratio of external debt balances to export earnings include Pakistan, Mongolia, Sri Lanka, Egypt, and Angola. Pakistan, among others, is already receiving IMF bailout loan assistance. UNCTAD estimates that developing countries will need a total of US$ 310 billion to pay off their external debt this year, equivalent to 9.2% of their outstanding external debt stock, at the end of 2020.

The U.S. and European interest rate hikes will also trigger capital outflows from emerging markets, leading to turmoil in emerging market currencies & financial systems and higher financing costs. Some investors, such as European and U.S. pension funds, have begun to reassess their overseas investment strategies. In 2020, the US$ 7.5 billion Philadelphia Municipal Retirement Fund lowered the allocation target for emerging market equities from 4% to 3% to "avoid risks and reduce volatility" and bought more assets such as shares of medium-sized US companies.

Bond yields in developing countries have continued to rise since September 2021 in anticipation of interest rate hikes in developed countries, a clear sign of tightening financial conditions. We believe that central banks in emerging economies should follow the tightening path set before the war and raise interest rates in response to worsening price pressures, except for the economies most affected by the Russia-Ukraine conflict, which could start with a comprehensive reassessment of the impact of the Russia-Ukraine crisis on them. The commodity exporters such as Latin America, whose fiscal situation is expected to improve, can moderately increase their support to low-income groups and SMEs.

On the other hand, to curb outflows of foreign capital and support local currency exchange rates, emerging markets are expected to raise interest rates at a greater rate than developed economies. It is expected that in the upcoming wave of global interest rate hikes, policy rates in major developed economies will increase by slightly more than one percentage point on average. In contrast, major emerging markets will raise interest rates by 1.5 percentage points on average.

Risk Warnings and Disclaimers

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Devin

Oman recorded a 210 million Omani riyals ($546m) budget surplus at the end of February, compared with 457 million riyals deficit a year earlier, as oil prices nearly doubled, according to the Ministry of Finance.

Net oil revenue in 2022 rose 81 per cent year on year to 1.09 billion riyals during the first two months, as the country sold its crude for an average of $81 per barrel compared with $42 per barrel a year ago, according to the ministry's monthly bulletin on fiscal performance.

Average oil production increased to 1.01 million barrels per day, compared with 953,000 barrels per day during the same period in 2021, it said.

The Ministry of Finance "seeks to utilise the surplus arising from higher oil prices to reducing fiscal deficit and minimising the cost and risks of its debt portfolio", it said.

Last month, Sultan Haitham, Ruler of Oman, said that the country plans to use revenues from soaring oil prices to reduce its public debt and support spending on government projects, while ensuring inflation does not affect basic commodity prices.

Crude prices hit a 14-year high in March, touching nearly $140 a barrel as the Russia-Ukraine conflict led to sanctions on the world's second-largest energy exporter, threatening to widen the gap between stagnating supply and growing demand.

While prices have retreated they remain above $100 a barrel, with Brent, the global benchmark for two thirds of the world's oil, up about 37 per cent since the start of this year.

Oman, a relatively small crude producer compared with its Gulf neighbours, is more sensitive to oil-price swings and was hit hard by the Covid-19 pandemic and the collapse in oil prices in 2014.

However, higher oil prices in 2021, along with fiscal reforms, helped narrow government deficits.

Oman's government revenue rose an annual 75.6 per cent to 1.9bn riyals by the end of February, on higher oil and gas revenue, VAT receipts and higher collection of fees, the finance ministry said.

Public spending rose 10.2 per cent year on year to 1.7bn riyals driven by interest payments, investments for civil ministries and gas purchases and transport, the monthly bulletin showed.

The Ministry of Finance said it will reduce the public debt by more than 2.85bn riyals at the end of April 2022, as part of its debt management strategy.

Oman's 2022 budget allocated 4bn riyals to meet debt obligations, including the repayment of 2.7bn riyal loan principals and payment of 1.3bn riyals in loan interests.

In terms of debt management, Oman repaid 1.49bn riyals in loans at the end of March, including an 850m riyal loan prior to its maturity, the finance ministry said.

Oman is also preparing to pre-pay 1.36bn riyals worth of loans at the end of this month, it said.

The country has also reprioritised its development projects in terms of their urgency, cost, and economic and social return, the ministry said. Total spending on development projects during 2022 rose to 1.1bn riyals after Sultan Haitham issued directives to add 200m riyals to the development budget.

More than half of the government's development budget (53.5 per cent) will be allocated to infrastructure projects including roads, airports, ports, irrigation and water resources, town planning and municipal services, government administration, environment and pollution control.

Another 23.5 per cent of the budget will be allocated to social services such as education, vocational training, health, information, culture and religious affairs, community centres and youth centres.

About 15 per cent is allocated for services such as housing, utilities and tourism. About 7.7 per cent will be spent on production of goods from crude to fish.

Last week, S&P Global Ratings upgraded Oman's long-term foreign and local currency sovereign credit rating for the first time since 2007 to BB- from B+, citing higher oil prices, rising hydrocarbon production and the government's fiscal reform programme. The credit rating agency also revised the Gulf country's outlook to stable.

A BB rating is a speculative grading that implies the issuer is less vulnerable in the near term.

"The stable outlook balances the significant improvement in the government's balance sheet over the next three years against higher medium-term fiscal pressure," S&P said.

The agency expects Oman's economy to grow in 2022 and 2023 with GDP expanding nearly 4 per cent this year and then moderating to about 2.2 per cent on average over 2023-2025.

"Over the next three years, we expect the non-oil sector to be the leading driver of growth. We forecast non-oil growth averaging 2.2 per cent over 2023-2025, relative to 1.8 per cent in 2022," the agency said.

It expects Oman to achieve a fiscal surplus of 5.7 per cent of GDP this year, from the budgeted deficit of 4.6 per cent of GDP.

Source: The National News.

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Owen Li

On May 23, 2020, the European Union suspended its fiscal rules. It was the first time this had happened since the Stability and Growth Pact (SGP) was created in 1997.

The measure was exceptional, though it was justified by the exceptional circumstances of the coronavirus crisis. From one day to the next, countries had to cope with unprepared and overwhelmed public health systems while throwing a lifeline to millions of households and businesses whose livelihoods were choked off by lockdowns. With each new Covid-19 wave, the scale of financing needs increased dramatically. In such a context, requiring governments to restructure high deficits and public debt was out of the question.

How long the suspension would last, and under what conditions the rules would be reinstated, was not specified at that uncertain moment. For some time, however, January 2023 was evoked as a possible target date. The European Commission had been expected to submit a proposal in that direction in the coming weeks.

Tragic setback

Plans to reactivate the SGP were instantly compromised on February 24, when Russia invaded Ukraine. The pandemic is far from over, and already another major crisis has emerged. Once again, EU governments are struggling to decide which fiscal and monetary policies are needed to respond to this new economic shock.

Member states are only now starting to assess how the war might affect them in the short and medium term. There is no doubt that the new refugee crisis, along with the spillover effects of drastic sanctions against Russia, will have serious economic repercussions. Their effect will be magnified if a ban on imports of Russian oil and gas, let alone proposals of a total trade embargo, are adopted by European members of NATO and the EU, along with their allies. The very least the EU can expect is a severe economic recession, coupled with a surge in energy prices and overall inflation. Stagflation is looming. Potentially, its consequences may be far worse than anyone can imagine now.

In such a context, established policy paradigms could be thrown out the window. Is the definitive end of the SGP nearer than we thought? Has the very idea of EU fiscal rules been rendered obsolete, as many politicians and economists already claim?

Fiscal straitjacket

The current fiscal targets date back to 1992, when the Maastricht Treaty set up the original architecture for economic governance in the Economic and Monetary Union (EMU). The EMU was based on a single monetary policy, to be conducted by an independent European Central Bank (ECB) on one side, and on a set of coordinated national fiscal policies on the other. At the time, fiscal discipline was considered an indispensable prerequisite for a monetary union that did not possess a common fiscal authority or capacity.

The SGP, signed five years later, was supposed to implement the quantitative reference values for the EU's public debt and deficit rules as defined by the Maastricht Treaty. It was stated that the annual government deficit must not exceed 3 percent of GDP, and that the general government debt must not exceed 60 percent of GDP. In the 1990s, these figures coincided with the average economic situation of the 12 countries negotiating the Treaty.

In other words, the EU's fiscal framework was created in a context of what by today's standards would be considered low public debt and fast economic growth. Contemporary economies have not come anywhere close to experiencing such favorable conditions for many years.

Is There a Future for The Stability and Growth Pact?_1

To take the debt criterion, for example, at the end of the third quarter of 2021, the general government debt-to-GDP ratio stood at 200.7 percent for Greece, 155.3 percent for Italy, 130.5 percent for Portugal, 121.8 percent for Spain, 116 percent for France and 109.6 percent for Cyprus. For the whole euro area, the debt ratio amounted to 97.7 percent.

Debt tsunamis

As Europe faces its worst security crisis in decades, debt burdens will only increase. At the EU's Versailles summit on March 10, member states jointly committed to massive increases in defense spending and investments in innovative technologies to become more self-sufficient in the production of food, energy and military hardware. Even in a best-case scenario, the consequences of the Russo-Ukrainian war will have a long-lasting effect on the EU. In case of a protracted war or serious escalation, the International Monetary Fund has warned that the impact could be "devastating."

Even fiscally conservative countries such as Germany, Austria and the Netherlands, along with low-debt member states in Scandinavia and Eastern Europe, which have normally insisted on the importance of getting the bloc's public finances on a sounder footing, have recently conceded that returning to the normal implementation of the SGP is inconceivable. None of them wants to see southern members going down the path of austerity again. The disastrous mismanagement of the Greek debt crisis and near-Grexit in 2015-2016 (sometimes dubbed "Graccident," for an unintended Greek exit from the euro area) still very much weighs on policymakers' minds. In hindsight, the whole episode is considered one of the EU's biggest policy failures.

Moreover, all parties involved are worried that the EU's fiscal framework, if reinstated, would hamper not only the bloc's post-pandemic recovery (not to mention its unpredictable and still distant postwar recovery), but also efforts to deal with the longer-term economic challenges of climate change and aging populations.

The Commission's plan to reinstate the SGP could indeed conflict with another one of its flagship projects presented last year – the so-called Fit for 55 package under the European Green Deal, which aims to reduce net greenhouse gas emissions by at least 55 percent by 2030, as compared to 1990 levels. The Commission estimates that funding this transition to clean energy will cost EU countries about 520-575 billion euros a year.

At the same time, aging populations will significantly worsen the fiscal outlook, as healthcare and pension expenditures are likely to explode in the coming years. Coping with these budgetary stresses all at once will require backbreaking effort and sacrifice, especially from high-debt member states still struggling to emerge from the Covid-19 recession.

So far, EU leaders seem to have fallen in line with a riff on John Maynard Keynes' famous quip made by French economist Jean Pisani-Ferry in 2019: "When facts change, change the pact." All agree that the current phase of pre-negotiation should serve as a useful pause to consider how the EU's fiscal corset could be loosened. Consensus must be reached before the rules are reinstated, it is argued.

Too smart

Calls for reform are not new. The SGP has been subjected to harsh criticism since its inception. At the time, many said its one-size-fits-all framework was too rigid. The pact did not account for country specificities or allow the flexibility to respond to unforeseen circumstances. Worse, it was economically damaging. By constraining government action during crises, critics said, it contributed to making recessions longer and more severe. Moreover, rules that are too strict often end up being ignored. In 2002, then-EU Commission President Romano Prodi bluntly called Europe's fiscal rules "stupid."

Between 2005 and 2015, several far-reaching reforms were implemented, including two voluminous packages of regulations and directives commonly labeled six-pack and two-pack. Their purpose was to improve compliance with fiscal rules by tightening the EU's monitoring of member states. In this context, a sophisticated framework for integrated surveillance and coordination, known as the European Semester, was created.

The new generation of fiscal rules came with its own flaws. In the blink of an eye, the rules had moved from "stupid to too smart," a group of researchers wrote in 2018.

In a recent Financial Times opinion piece, French President Emmanuel Macron and Italian Prime Minister Mario Draghi complained, yet again, that the rules are "too obscure and excessively complex." Member states find them very hard to understand, due in part to a maze of constantly revised, often conflicting and overlapping sub-rules, provisions, exemptions and indicators.

Is There a Future for The Stability and Growth Pact?_2

French economist Olivier Blanchard ironically compared the process of rebuilding the EU's fiscal framework to the Cathedral of Avila. After years of amendments and reinterpretations, the SGP's architecture had become absurdly cluttered, subject to so many changes and additions that its original structure was hardly recognizable.

Countries quickly learned how to exploit loopholes in the opaque system. Many systematically delayed fiscal adjustments, notably through "creative accounting gimmickry." Critics also highlighted unequal treatment of member states, arguing that sanctions against noncompliers were applied unfairly. While punitive proceedings for violating EU budgetary rules were instigated against several southern member states, France and Germany were routinely spared.

In the end, though, no fines have ever been imposed on a member state for violating the SGP. That has exposed the Commission to allegations of leniency toward fiscally irresponsible governments. Some analysts saw such practices as a manifestation of the EU's growing politicization, which resulted in a watering down of the Pact and, ultimately, the loss of its credibility.

Proposed remedies

The Funcas Europe platform recently listed a range of redesign proposals made in light of the Covid-19 pandemic. Several stand out as potential inspiration for SGP reformers.

German economist Achim Truger suggests raising the debt limit from 60 to 90 percent of GDP. The 3 percent deficit limit could also be "adjusted upward," he argues. However, these would require a formal amendment of the Maastricht Treaty – a complex task given constant political friction between the member states.

Enrico D'Elia suggests that the fiscal rules compare the debt and deficit figures to revenue rather than GDP. A study requested by the European Parliament calls for the implementation of a "green golden rule" that would exempt capital investments on environmental projects from the debt totals. And ECB researchers, for their part, have proposed shifting the fiscal rules from sanctions for noncompliance to rewards for compliance.

The European Fiscal Board (EFB) insists on the importance of completing the EMU by finally building in a permanent central fiscal capacity. For many years, this Fiscal Union has remained an unreachable goal. Why should it be any more attainable now?

The EFB thinks the one-off recovery plan, NextGenerationEU, could be a step in the right direction. Embedded in a reformed EU budget, this fiscal instrument could be enlarged and made permanent, giving the bloc an ability to respond swiftly to severe shocks such as we are experiencing now or to implement high-priority common investments, such as green energy or defense projects.

All of these proposals agree on one point: the EU's fiscal rules need to be simplified.

Rules vs. discretion

However, the aforementioned Mr. Blanchard, also a former IMF chief economist, believes it is an illusion to think that such fiscal rules can be "simple." He adds that it is just as delusional to believe they can ever be "complex enough" to encompass contemporary economic reality.

Together with coauthors Alvaro Leandro and Jeromin Zettelmeyer, Mr. Blanchard has presented various versions of a research paper (whose latest iteration was published in October 2021) containing his own modest proposal: that quantitative fiscal "rules" be abandoned altogether in favor of "qualitative prescriptions" or "standards" that "leave room for judgment."

For example, it could be stated that "member states shall ensure that their public debts remain sustainable with high probability." In other words, in assessing a country's effort to maintain fiscal discipline, what should count are not statistical benchmarks such as debt-to-GDP ratios but rather "qualitative standards" that distinguish good from bad behavior and focus more on debt trajectories and sustainability.

How such "standards" would be enforced without opening the door to discretionary excesses remains an open question.

Like the other proposals, Mr. Blanchard's is built on the assumption that the low interest rate environment we have known for many years will persist for "some time to come." As long as borrowing costs stay close to zero, he believes, excessive debt would not represent an intolerable threat.

A very different picture emerges, however, if one envisages an environment of steeply rising public debt, sluggish economic growth and higher interest rates. This has become today's baseline scenario. Indeed, the ECB is expected to start a monetary tightening cycle by the end of this year. And Economy Commissioner Paolo Gentiloni recently warned that fiscal rules limiting government borrowing could remain suspended until at least the end of 2023.

These decisions might be wise in the current context. But the downside is that the specter of sovereign defaults will loom into view sooner rather than later. This makes it once again clear that without an effective framework for fostering fiscal discipline, the EMU is simply unviable.

Source: GIS

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Jason

At 09:00 ET on April 5, Fed Governor Brainard delivered a speech on inflation. Most of his speech was boring, and she talked about monetary policy near the end. However, the brief conversation helped push the dollar above 99, its highest level since March 7, setting off a bout of market volatility. Brainard's formulation of monetary policy can be reduced to one sentence—faster, more aggressive shrinking of the balance sheet.

The original words are as follows:

The Fed Maybe More Hawkish Than Expected_1

The market has adapted to the recent remarks by many Fed officials that they have repeatedly emphasized raising interest rates by 50 basis points. But Brainard was the first to be so explicit and tough on shrinking the balance sheet; this may also be the reason for the surge in the dollar. In addition, this may also indicate that the Fed has already reached a consensus on the path of shrinking the balance sheet. Because of the reporter's question-and-answer session after the March meeting on interest rates, Powell had said that he would discuss shrinking the balance sheet in the minutes of the March meeting. It can be seen that Brainard's attitude towards shrinking the balance sheet is very tough; she is probably reminding the market in advance to prevent another market panic. Brainard only revealed that there would be a faster and stronger reduction of the table, and more details may be shown in the minutes of the March meeting. The Fed Maybe More Hawkish Than Expected_2

The Fed Maybe More Hawkish Than Expected_2

From Brainard's speech, it is clear that everything is currently focused on curbing inflation. In addition, it expressed a faster and stronger pace of shrinking the balance sheet, which is consistent with the speech of the Fed's executive vice-chairman and the administrator of the System Open Market Account (SOMA), Lorie Logan, on March 2. According to Logan's disclosure, active selling is unlikely, and there is a high probability of continuing to adopt the upper limit of redemption at maturity set in the last round, which makes the process of shrinking the balance sheet is more predictable. In addition, if the economic outlook deteriorates and interest rates are adjusted mid-cycle (similar to 2019), the cap method can also prevent a pro-cyclical reduction in SOMA holdings due to a large number of mortgage prepayments sex. But whether it is true, as Logan said, it will have to wait until the minutes of the March meeting to confirm.

In addition, in Brainard's speech, it can also be known that shrinking the balance sheet has a higher upper limit parameter, and the speed of reaching the upper limit will be faster. The so-called upper limit means that the Fed shrinks the balance sheet by setting a limit, such as 20 billion in a single month, and only the portion above this limit will be reinvested.

For example, assuming that 100 billion assets mature in a single month, the Fed reinvests 100 billion minus 20 billion, and the obtained 80 billion is the upper limit. An increase in the cap means less and less of the Fed's assets to be reinvested, the smaller the balance sheet, and the more assets the market needs to take on (tight liquidity).

Combined with the previous speeches by Brainard, it can be summarized as follows: whether it is interest rates or shrinking the balance sheet, it is correct to continue to tighten.

If you look closely at Brainard's speech, you will find that most of her speech revolves around the imbalance of household inflation, and even quotes the opinions of two former Fed chairmen in the literature reference section:

Paul Volcker pointed out that dual mandates are not a proposition that must be chosen between the two. In addition to posing a threat to sustained economic growth, runaway inflation will also ultimately have an impact on employment.

Arthur F. Burns noted in the late 1960s that "there is no doubt that the poor are the main victims of inflation."

In addition, from the perspective of people's livelihood, Brainard made a more practical and intuitive interpretation of the inflation problem. For example:

Low-income Americans spend 26% of their income on household food and transportation, compared with 9% for high-income Americans. Housing spending accounts for 45% of low-income Americans' income, compared with 18% for high-income Americans.

Low-income Americans spend 77% of their income on necessities, while high-income households spend 31% on necessities, less than half that of low-income Americans.

CPI and PCE have limitations and cannot accurately measure the differential inflation perceived by different income groups, etc.

This shows that high inflation and inflationary expansion have become a problem for the whole society. When ordinary people have difficulties in living because of persistent high inflation, will they complain about the Fed? Maybe, but it is more likely to vent anger in the face of the government, and it just so happens that this year is a midterm election year, and the way people express their dissatisfaction may be to turn to the Republican Party. This shows that the inflation problem may have gradually moved closer to a political issue, and Trump was removed from office because of the pandemic not long ago.

This also shows that the Biden administration may put pressure on the Fed to control inflation as soon as possible, and intensifying tightening is the best choice to achieve results in a short period.

Finally, don't forget that Brainard is a Democrat.

Brainard's Speech

Lorie Logan's Speech

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Tragic setback

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Debt tsunamis

Too smart

Proposed remedies

Rules vs. discretion

Source: GIS

The Fed Maybe More Hawkish Than Expected

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