Time for a rate hike
August 17, 2015, 7:55 am   

Pretty much everyone in the world wants the Federal Reserve to begin its "rate liftoff." September is the latest target date for this market consensus. But permit me one dissenting question: Are you sure?

Or as the saying goes, be careful what you wish for.

Take a look at a bunch of forward-looking, inflation-sensitive market indicators. They`re flashing deflation, not inflation. In the past year or so, gold has dropped to $1,100 from $1,300 and oil has plunged more than 50 percent to $42 a barrel.

A 20-percent rise in the dollar has completely erased inflation fears. Economist Michael Darda calls it a de facto tightening. The end of quantitative easing and the expectation of higher future rates are behind the King Dollar move. Inflation expectations have been crushed.

So normally, with a rising dollar and all these commodity declines, the Fed would be thinking about lower rates and easier money.

But there`s more. In the Treasury bond market, the yield curve has flattened. Anticipating a couple of Fed rate hikes, 2-year Treasury paper has bumped up about 30 basis points over the past year, while the yield of the 10-year note has dropped 20 basis points. Now, it`s not an inverted curve, where short rates move higher than long rates — so there`s no recession forecast. But as investor Brian Kelly pointed out many weeks ago, if Fed rate-hiking is accompanied by a drop in bond yields, we`ll have another deflationary signal.

In fact, the so-called Treasury break-even inflation spread (the difference between the market rate, which is about 2.2 percent, and the inflation-protected rate, which is only 56 basis points) has actually fallen 50 basis points over the past year. Indeed it should. The year-to-year change in consumer prices is flat. So is the change in the consumer price deflator, something the Fed watches carefully.

Just last week import prices registered a 10.4-percent decline, another consequence of the sharp increase in King Dollar. Meanwhile, producer prices in July fell by nearly 1 percent. If you use the old PPI measure for finished goods, these prices have dropped 2.6 percent.

And if you are a monetarist, the 12-month change in the M2 money supply is only 5.6 percent. With nominal GDP through the second quarter coming in at a meager 3.3 percent over the past year, the turnover (or velocity) of money is still falling.

Now, to some extent, this is all statistical mumbo jumbo. But if you are a Fed watcher it`s important. Some people argue that the Fed should raise its target rate because we`ve had steady jobs growth and a low unemployment rate. Putting aside the validity of the U-3 unemployment rate (labor participation and employment/population ratios are abnormally low), the fact is that more people working doesn`t cause inflation. As Milton Friedman taught us years ago, inflation is a monetary phenomenon: too much money chasing too few goods, and a sinking currency.

Well, there`s not much money being created, nor are there many goods being produced. And that`s the message of inflation-sensitive market indicators. Price stability. What`s wrong with that?

True enough, we`ve had a zero Fed target for nearly seven years. It can`t go on forever, nor should it. At some point the largest economy in the world has to have a positive central bank target rate.

But for now, I`m unpersuaded by concerns about a bubble. Low money growth, low nominal GDP growth, low commodities, and a flattening yield curve don`t suggest anything`s about to pop. There may be bubbles in certain asset sectors, but not overall.

Former Fed governor Wayne Angell, one of the authors of the commodity-price-rule approach to monetary policy, said recently that even though commodity indicators are weak, it`s "time to test the water." Well, okay. He`s a very smart guy and he was a sound-money Fed governor. So I guess I can live with a small (one-and-done) quarter-point rate hike. But I`ll finish where I began: Be careful what you wish for.

My hope: The Fed moves at the pace of an injured snail. Frankly I`m not even sure it should do that much.



m1.png m2.png m3.png m4.png m5.png
f1.png f2.png f3.png f4.png f5.png
+ =
Exchange Rates
EUR/USD 1.0661
EUR/BRL 3.4097
EUR/AUD 1.4225
EUR/TRY 4.0387


Jan16      01:55
  1. Humidity 47%
  2. Downwind
  3. Winds 0 kph
Latest Videos
VIDEO: The Biology of Bliss and the Human OS - Jamie Wheal
Terror and Tourism: Changing the Travel Landscape
Earth In 2050 - HD Documentary 2015
The drive for gender equality in corporate Japan
Plane touches down then aborts during storm (VIDEO)
The Fermi Paradox II — Solutions and Ideas – Where Are All The Aliens (VIDEO)
Money Survival Tips for Millennials (VIDEO)
Lightning strike explodes a tree (VIDEO)
The Moons of Mars Explained (VIDEO)
3 Reasons Why Nuclear Energy Is Awesome! (VIDEO)
3 Reasons Why Nuclear Energy Is Terrible! (VIDEO)
Nuclear Energy Explained: How does it work (VIDEO)
Latest Photos
best cities for small businesses
Best Jobs in America (PHOTOS)
Inside the coolest private jets (PHOTOS)
The best hotel club floors in the world
Winning Images from the 2015 National Geographic Traveler Photo Contest
PHOTOS: Raging Wildfires Prompt Major Evacuation
Amazing Geometry Cities from air - Photos
Photos Bangkok Get snow - Opens Snow Village
Stunning Summer Aerials from Around the World (PHOTOS)