…and the Fed’s manipulation of them. Sober Look has six thoughts on the matter (though they don’t couch it in terms of manipulation), and so do I.
- While the Fed officially talks about not being focused on the currency markets, the recent dollar rally should give them some food for thought. The global “currency wars” have sent the trade-weighted US dollar to the highest levels in over a decade. This will continue to put pressure on US manufacturing (and even some services sectors) as US labor and other costs of production rise relative to other nations.
Not that much. Manufacturing, per se, hasn’t been that big a deal for our economy this century, for all that it’s making a useful comeback lately. Too, the “currency wars” are a response to the PRC’s revaluation and have mostly played out. Most importantly, the “highest levels in over a decade” isn’t all that high, even in relative terms. This is a factor that’s largely irrelevant.
- Commodity prices, led by crude oil and industrial metals, hit new multi-year lows, reigniting disinflationary pressures. Note that the Bloomberg Commodity Index is at the lowest level since 2002.
To the extent this is applying any pressure at all, it’s a deflationary one—and so a reason to raise interest rates, an inherently inflationary move, since rising interest rates are intrinsically inflationary.
- Driven to a large extent by commodity prices as well as economic weakness in China, US breakeven inflation expectations are declining sharply as well.
This is another who-cares concern. The breakeven inflation rate is the difference in yield on Treasury debt and TIPs of the same maturity that makes an investor not care which he buys; he gets the same yield. Both Treasury and TIP rates vary with market pressures (or would were the Fed not artificially suppressing rates), and so the only effect here is lag between one moving and the other moving to compensate.
- Some point to the recent stability in “core inflation”, with CPI ex food and energy remaining around 1.8% and providing support for a less accommodative policy. However the main driver of this stability is the rising cost of shelter. Core CPI excluding shelter is below 1% (YoY [year-on-year]).
One of the Fed’s dual statutory mandates is price stability, and the Fed has defined the inflation rate safely consistent with that to be 2% inflation (YoY). Inflation has been below that for lots of years because the Fed has artificially suppressed interest rates instead of letting them answer to market forces. As noted above, rising interest rates are inherently inflationary; if we’re to get to the Fed’s 2% target, interest rates need to be allowed to rise to levels historically consistent with 2% inflation.
- The biggest argument for a rate hike is the expectation of increasing wage pressures. US labor markets continue to improve and at some point – the argument goes – wage growth will accelerate. However, we haven’t seen much evidence for wage pressures thus far, as average hourly earnings continue to grow by about 2% per year (nominal). With the recent dollar strength, US corporations will speed up shifting production abroad – especially Mexico, limiting wage growth in the United States.
Sober Look is, in the main, right on this. Which puts the thing in the who-cares category. Sober Look does expand on this by worrying that stagnant wages coupled with higher interest might start to price renters out of their rented homes. An interest rate régime consistent with the Fed’s target inflation rate won’t present that risk though. What will present the risk is a separate problem of the Fed’s creation, and that’s the enormous inflationary pressure it’s created with its excessive money printing since 2009.
- Finally some at the Fed have been concerned about bubbles forming in the financial markets. In recent weeks however, the markets took care of that, as a healthy dose of risk aversion returns to the markets[.]
As they say. And so this is a who-cares item.
In sum, my thoughts center on sticking to a plan and a rate rise/release is necessary for one reason or another. Raise the rates/let them float (at least a bit more) in September as planned.