We heard from Stanley Fischer the other day and he seems ready to raise rates soon. “All told, with the unemployment rate not far from levels that most Federal Open Market Committee (FOMC) participants view as normal in the longer run and the rise in the participation rate, I see the U.S. economy as close to full employment, with some further improvement expected.” With respect to the other mandate he said, “As oil prices and the dollar stabilize, the drag on consumer price inflation from these sources ought to dissipate, and inflation will likely move closer to 2 percent.” He said “nearly all FOMC participants anticipated an increase” in rates “by the end of this year” and said the reason why they didn’t hike in September was because “we chose to wait for further evidence of continued progress toward our objectives.” Years of evidence apparently wasn’t enough. He then went on to say “the federal funds rate” is “modestly below the neutral rate” which implies they are only “modestly accommodative.” You will be hearing more about this “neutral rate” but it’s a feedback loop the Fed has put themselves in.
I say this because many, including myself, easily argue that a main reason why economic growth is modest is because easy money (globally) allowed for an enormous amount of debt to be accumulated. That has also created excess capacity everywhere. That in turn leads to slower growth. We’ve also pulled forward so much economic activity that we’ve run out of things to pull forward for now. Thus, slower growth as a result of years of excessively low artificially set interest rates then leads the Fed to thinking that growth has slowed in spite of them (not because of) which then leads to a snail’s pace progression of rate rises and to this discussion of a low “neutral rate.” Just look at housing for example, new home sales are still about 15% below its 25 year average due to the damage done from the last Fed induced bubble.
On the belief that the Fed will just wait until December to hike (as they seem so inclined to do at some point before yr end) because of the proximity of the November meeting to the election, if we keep hearing ‘let’s hike’ comments from Fed members, especially the important ones like Fischer, we can easily argue that by NOT raising rates in November they would be acting political.
As hinted by the selloff in Treasury futures yesterday, the US 10 yr yield is again peeking above the 1.75% level (where it closed on June 23rd, the day of the UK vote). The 2 yr note yield is at a 4 month high. This follows the selloff in European bonds yesterday (and are bouncing slightly today) driven by UK gilts. JGB’s overnight also saw higher yields with the 10 yr yield higher by 1.5 bps to -.045% and the 40 yr yield was up by 2 bps to .62%. The 40 yr yield was 7 bps three months ago. With the Atlanta Fed GDPNow Q3 forecast down to 2.1% from 3.8% on August 5th it’s hard to argue that the near 20 bps increase in the 10 yr US note yield since August 5th is because the economic data has gotten better. Thus, I continue to emphasize that this back up in global long rates has a different complexion than previous moves higher over the past few years. Whether the Fed raises short rates at some point in the next few months is certainly important but the rise in long term rates IF it continues may have much more relevance especially if it’s happening because markets are beginning to question the behavior of central banks.
US long rates are not just some innocent bystander that is getting impacted by the rumblings in Europe and Japan however. The 5 yr inflation breakeven is sitting at a 4 month high while the 10 yr breakeven is right below a 5 month high. We have now completely recycled out of the base effects of the sharp declines in energy prices. Gasoline prices are just about flat y/o/y, natural gas prices are higher by 29% y/o/y and heating oil is up by 6% y/o/y just as people start turning on their heat. The key offset however is food prices as they make up twice the level of energy prices within CPI. The CRB food stuff index is lower by 9% y/o/y. These figures come on top of services inflation ex energy which ran at a 3.2% y/o/y pace in August. We may start to see some rent increase moderation but likely not for medical care.