Fed hold an excuse for spending

Animal Spirits

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- 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, Ja pa n e s e 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 do e s n’ t happen in the “medium term.” However long that may be.