Is good news about to become the ultimate bad news. JPMorgan's Michael Feroli notes that (for the first time in recent memory) is pulling forward their projected date for Fed tightening and the inevitable end of the free-money cycle. Based on a belief in the committee's limited appetite to wait in inflation and today's report, JPMorgan notes a Q2 tightening seems plausible. Of course, this will be repeated mantra like as evidence of escape velocity and the status quo is back but, as we noted here [7], while policy economists claim that interest rates can be “normalized” at no cost; a more likely scenario is that policy “normalization” leads us directly into the next bust [7].
Via JPMorgan's Mike Feroli,
We are pulling forward our projection for Fed tightening (the first time we have done so in recent memory); we now see lift-off occurring in 15Q3, rather than 15Q4. For year-end 2015 we see the funds rate at 1.0%, for 2016 2.5%, and for 2017 3.5%.
The inexorable decline in the unemployment rate, alongside firming core PCE inflation, is dramatically reducing the degree to which the Fed is missing on its mandate. It's true that the decline in unemployment is occurring alongside anemic GDP growth (we are also today lowering our tracking of Q2 GDP from 3.0% to 2.5%), but the Fed's mandate is not to ensure strong productivity growth, it's to get the economy back to full employment and price stability, and even broad measures of labor underutilization have been showing marked improvements in recent months. It's also true that wage inflation has not materially accelerated, but unit labor costs are picking up, and we believe the Committee has only limited appetite to wait on inflation until they can "see the whites of their eyes."
Indeed, after today's' report a Q2 tightening seems plausible. If the unemployment rate continues the recent surprising pace of descent such a move is even likely; nonetheless, we hope and believe better productivity and labor supply outcomes will slow the pace of decline in unemployment in coming quarters. We do not see the recent data as cause to accelerate the pace of tapering; there has been little agitation -- even from the hawks -- for such a move.
And what happens when rates rise... (as we detailed here) [7]
It stands to reason that when the Fed eventually lifts
interest rates, we’ll see the usual effects. After a sustained rise in
rates, you can safely bet on:
- Fixed investment and business earnings dropping sharply
- GDP growth following investment and earnings lower
- Many people losing their jobs
- Risky assets performing poorly
These consequences follow not only from the arithmetic of debt
service and present value calculations, but also from the mood swinging
psychology of entrepreneurs, lenders and investors.
Yet, policy economists claim that interest rates can be “normalized” at no cost.
[8]
[9]
[10]
Now, many readers will surely dismiss these results by insisting that
“this time is different.” We beg to differ. By our estimates, the
economy and financial markets are as vulnerable to higher rates as
they’ve ever been. Here are a few reasons:
- The present expansion is weaker than any other post-World War 2
expansion, suggesting that it won’t take much of a slowdown to push the
economy into recession. - Monetary policy has been exceptionally loose for longer than ever
before, allowing financial markets more time to become overpriced and
complacent. - There are many more risk-takers in the global economy who’ve learned
how to exploit cheap dollar policies than there were in, say, 1955, the
start of the period shown in the charts. - Most importantly, aggregate debt is at or near record levels, not only in the U.S. but also in other large economies.
Bottom line
Our conclusion is to reject forecasts calling for the economy to
power right through interest rate hikes without stumbling. A more likely
scenario is that policy “normalization” leads us directly into the next
bust. Alternatively, the Fed might abort its planned rate hikes,
allowing economic and financial market imbalances to continue growing.
Either way, we can expect recurring booms and busts until our monetary
approach is rebuilt on stronger policy principles.
