Trying to estimate what are a fair level of interest rates, I feel today’s rate are fair. A 2016 article by the Fed says real neutral rate is close to zero and use PCE inflation rate so that implies 1.5% nominal short term rate is OK, we are at 1.42% Fed Funds now, so no problem with rates. See August, 2017 Bloomberg article. The neutral real rate declined to negative 0.22 percent, from 0.12 percent in the first quarter of 2017. Recently is has increased to negative 0.1%. James Bullard of @stlouisfed (President of the St. Louis Fed) concludes desire for safe assets is the largest driver of the drop in real natural rate of interest. Today he
Some inflation measures are rising and there appears to be an intermediate term trend of gently rising inflation and a growing economy. This could threaten bonds. However, I believe this is merely a brief intermediate or short term cyclical trend and that the fundamental dominant paradigm of a secular trend of bond-friendly disinflation will continue. At the end of a nine year economic cycle the final year often has a sudden upward burst of inflation, pay raises, less unemployment, more GDP growth, etc. However, this phenomenon may be the last hurrah before the once in a decade recession. It is like stocks’ charts where a stock, nearing its top, goes through a “blow off phase” where the price
Economists may focus on the short term overnight Fed Funds rate, now roughly 1.4% but the free market short term rate is the 90 day T-Bill yield, now at 1.64%. An even more objective, less manipulated rate is the two year Treasury Note, now at 2.26%. Adjusted for the fact it is free of state tax means its taxable equivalent yield is 2.48% for residents of CA, NY, etc. Assuming PCE inflation is 1.5% and that Owner’s Equivalent Rent component of inflation needs to be adjusted downwards shaving off at least 15% of this then the PCE should be 0.22% lower or about 1.28%. The difference between 2.48% and 1.28% is a short term risk free real yield of
If stocks are overpriced 2 times fair value because of irrational emotions of the crowd, then what about bonds? No one seems to be emotionally in favor buying bonds yielding about 2% or even 3%, so it seems that market is dominated by logical minded professionals seeking to use bonds as a haven to protect from a contingent risk of a crash of risk-on assets. It is possible the decision to increase one’s fear of rising inflation could cause, on the margin, some bond investors to make an emotional leap out of bonds. If stock investors overpaid for stock by 2x because emotions perhaps some bond investors will misdiagnose the threat of inflation and push down bonds prices to a
The uninhibited boost of the deficit by Trump and members of both parties in Congress on Feb. 9th may trigger fears of Banana Republic-style out of control deficits. The preponderance of evidence is that growing debt loads are not yet morphing into an inflationary Banana Republic. Some people are frustrated that Tea party Republicans were eager to oppose scary huge deficits during the crisis era in 2008 when TARP and the AIG bailout were needed to prevent a depression and now these same politicians appear to have abandoned their anti-deficit principles. However, it is a mistake to assume that, because of this change, to leap to the conclusion that Republicans have morphed into a party of Zimbabwe-style fiscal policy.
The federal budget signed on 2-9-18 will have annual $1Tril deficit in a 2 year average of FY 2018 & 2019. Of this $150B per year is from a tax cut passed 12-22-17 and $150B extra per year approved Feb. 9th, and $700B per year from previous administrations. So under Trump the annual deficit increased $300B a year or 1.5% of the $20T outstanding federal debt balance, or about same rate as PCE inflation, which implies on an inflation-adjusted “real” basis Trump didn’t increase the annual deficit, using a long term averaging of his tax cut program. (However, the initial years are front loaded with the biggest benefits). Of course, it would be better if no increase in debt occurred.
The fears that rising U.S. government’s deficits will morph into an inflationary Banana Republic are wrong. The rising deficit only increased by 0.75% a year as a result of Trump’s tax cuts. Since that’s less than the 1.5% PCE inflation rate then the inflation-adjusted deficit increase caused by Trump is actually a negative figure. John Williams of San Francisco Federal Reserve said the Trump stimulus program will only stimulate the economy by 0.1% a year. Thus I don’t expect it trigger an increase in inflation. A declining stock market and the recent increase in interest rates (short term rates may continue to rise this year) will act to cool down the economy and dampen inflation. The reason the deficit
Investing is done by those in the top 10% of society. These people are in careers that have the highest level of demand for their services in the labor market as a management or professional person. Currently the global economy has high demand for engineers, scientists, doctors, etc., thus inducing a high degree of financial self-confidence in the class of people who own stocks. The risk is that these investors use career self-confidence (the value of their human capital) to impute that they can afford to take on excessive risk in stocks. The danger is that this class of affluent people has incorrectly leapt to the conclusion that everyone is just like them. But people not in the top 10%
The BLS employment report issued February 2 hinted at a tightening labor market and thus rising inflation. But the facts are that the JOLTS survey issued February 6 said new hires fell to 5.488 million from 5.493 million in the past month. Also, since the population is growing then at least 0.1 million new jobs are needed each month just to have the unemployment rate stay the same. The BLS employment report referred to rising wages but those were mostly in supervisorial positions and concentrated in finance. So a commissioned stock broker getting a year end bonus (caused by bubble economics) may have accidentally created the impression that all workers are getting inflationary pay raises, and thus triggered the
Stocks recovered partly from yesterday’s crash but more importantly the stock market’s trendline has been broken and the stock market will eventually enter a bear market. In recent years the gravitational tug of the crowd’s emotions have swamped and overwhelmed fundamental analysis of stocks, resulting the market being hijacked by perma-bulls who rely on technical analysis to justify their actions. These investors try to justify their bullishness by claiming there is a technical trend shown as a pattern on a chart that somehow justifies forecasting that stocks will rise. But now these alleged trend lines have been broken. Since the stock market bulls depend on technical analysis, including trend lines, to justify investing then the bulls have less reasons