WAIT FOR IT
U. S. FED STATEMENT BAKES MORE WIGGLE ROOM INTO TIMING FOR NEXT RATE HIKE.
The U. S. Federal Reserve once again decided on Wednesday to hold its target interest rate. Readers of the tea leaves, as is their wont, were quick to point to the subtleties of the Fed’s language. For instance, its statement noted that “near-term risks” to the economy had receded and employment growth was strong. The popular interpretation is that the Fed is signalling a rate hike is coming, perhaps as early as September.
But who the heck knows. Last time around, on June 15, the Fed held rates because the May employment numbers were crappy and uncertainty was swirling about the then- upcoming Brexit vote. ( We know how that turned out.) Now, the latest jobs data are boffo and the Brexit shock already seems to be dissipating. And still, the Fed didn’t move.
One obvious reason — despite all the attention Fed- watchers pay to market shocks — is one that central banks in every developed country are grappling with: low inflation and its homely twin, slow economic growth.
For Fed chair Janet Yellen and her compatriots on the Federal Open Market Committee ( FOMC), inflation in particular has long defied their predictions of achieving target. It has remained and still remains (at one per cent) stubbornly below the Fed’s two-per-cent target.
Notably, it was stubbornly below two per cent last December, when the FOMC hiked for the first time in nearly a decade. Back then, the Fed said it was “reasonably confident” inflation would rise to the target two per cent over the “medium term.”
It might be instructive to consider what that “medium term” might mean. The Fed doesn’t really say. As a result, there’s lots of wiggle room for a miss.
But let’s assume it’s not six months. ( Inflation is below two per cent in the past six months; ipso facto, the medium term has not yet arrived.) Maybe it’s two to five years. Maybe it’s longer. Or maybe it doesn’t matter.
In fact, the real question may be whether inflation will return to target — not when.
It’s safe to say that markets believe the Fed is overoptimistic on inflation. One measure of that sentiment is to look at yield spreads between regular and inflationindexed five- year Treasuries — the so- called breakeven rate, which is available from the St. Louis Federal Re- serve. As of Monday, the fiveyear breakeven inflation rate stood at 1.34 per cent.
Want to go further out on the curve? Well, there’s the handy- dandy Fed’s “fiveyear, five-year forward inflation expectation rate,” which measures where investors expect inflation to be in the five-year period starting five years from today. As of Monday, the five- year, five- year stood at 1.66 per cent.
That’s f ar beyond t he medium term.
Besides i nflation, t he other specific problem for the Fed is that business spending remains weak despite low interest rates. U. S. net domestic private business investment rose steadily through to the first quarter of 2015, but it has since tapered off by about 20 per cent. Publicly traded corporations seem more inclined to use low borrowing rates to pump debt into their balance sheets (through, say, share buybacks) than to invest in growth.
Meanwhile, the other big measure for Fed action/ inaction — employment — is topping out. The unemployment rate in the States now sits easily below or at the Fed’s target of five per cent. It’s hard to see how further jiggery- pokery on rates will have much impact on jobs either way.
Perhaps, in standing pat, the Fed is beginning to realize monetary policy is approaching the limits of its effectiveness.
Of course, policy- makers now have something else to turn to: fiscal stimulus. Canadian politicians are all over this already, but the push toward government spending on stuff like infrastructure and green energy is taking off globally.
This week, Japanese Prime Minister Shinzo Abe surprised markets with a smackdown of a stimulus package, totalling 28 trillion yen, or $ 350 billion. ( Most estimates had it pegged at 20 trillion yen, or even less.)
In the U.K., fiscal stimulus to ward off the longer- term impact of the Brexit vote is widely expected. The European Union might not be far behind.
In the U. S., meanwhile, Hillary Clinton has pledged to spend US$ 275 billion on infrastructure if elected president, along with a host of other spending initiatives like “Make It in America” partnerships with manufacturers ( US$ 10 billion) and a US$60-billion “Clean Energy Challenge.” Donald Trump has his own plans to stimulate the economy, including tax cuts. But whoever wins the election in November, some kind of fiscal stimulus is likely in the works.
This might actually work against any September rate hike from the Fed, which might be reluctant to make any move until after the election. But that would be just another excuse to put off “normalization,” and there are already plenty of those. Policy-makers not just in the U.S. but globally have no end of “outs” to justifying spending money and keeping rates low.
That makes the most likely scenario one where governments, corporations and individuals will simply keep on taking on more debt. But hey, there’s an upside: the relative good times for asset prices are here to stay — at least, you know, until the Great Accounting.
We can only hope that doesn’ t happen in t he “medium term.” However long that may be.
SOME KIND OF FISCAL STIMULUS IS LIKELY IN THE WORKS.