Short term rates set to fall in a stable economy
Where does this leave us today? As I already noted, the U.S. economy is in a very good place, with the unemployment rate near a 50-year low, inflationary pressures muted, expected inflation stable, and GDP growth solid and projected to remain so. Moreover, the federal funds rate is now in the range of estimates of its longer-run neutral level, and the unemployment rate is not far below many estimates of u* [the structural rate of unemployment consistent with “maximum” employment]
Sustaining Maximum Employment and Price Stability – U.S. Fed Vice Chair, Richard H. Clarida (Economic Club of New York, New York, May 30th)
Despite what most in the alt-financial media are proclaiming, the macroeconomic data here in the United States seem to be consistent with stable economic growth. As we can tell from today’s speech, the Fed’s Vice Chairman seems to agree.
So why are Clarida and the Fed most likely going to begin lowering rates later this year? It’s because they must lower soon. Since they have announced they are going to begin buying up long-term Treasuries again, global yields have fallen quite a bit. The only outlier is the Fed funds rate.
The vice chairman of the Federal Reserve on Thursday identified factors that would cause the central bank to lower interest rates — but didn’t point out what could cause it to move rates in the opposite direction.
The speech from Richard Clarida to the Economic Club of New York appears to be moving the Fed slowly in the direction where markets already are, toward an interest-rate cut at the end of the year.
Clarida says low inflation, global risks could get Fed to cut interest rates – Market Watch, May 30th
The Market Watch article continues with a quote from today’s speech;
“However, if the incoming data were to show a persistent shortfall in inflation below our 2% objective or were it to indicate that global economic and financial developments present a material downside risk to our baseline outlook, then these are developments that the Committee would take into account in assessing the appropriate stance for monetary policy,” [Clarida] said.
Fed officials have been insisting over the last few months that inflation will pick up from levels that are running short of its target. Data released earlier Thursday revised lower inflation readings from the first quarter.
The reasons why inflation and interest rates continue to fade
Despite all the Cassandra calls for some sort of “big bang” (i.e. a jump in inflation and a large spike in global bond yields), price growth remains subdued and bond yields continue to fall. But why?
I understand it all seems so counter intuitive, given the historically low rate of unemployment, or as Clarida says, “the structural rate of unemployment consistent with “maximum” employment.” But if we analyze the current dynamic of the global central bank intervention, the answer is actually fairly straightforward.
Last year, I was concerned that the U.S. Fed and ECB were going to purposely pull the plug on the entire system. Recall how we were parsing all the interviews and speeches in light of what I thought was a seriously flawed game plan. In the wake of last decade’s manufactured crisis, the global central banks decided to place the global economy on a financial IV-drip, and last year it seemed as if they planned to remove it.
But that is all in the rear view mirror as it turned out to be a bluff to see how far they could go before the markets began to collapse. They clearly could not get away with much.
Okay. Now the Fed and ECB will begin buying debt again and will work to lower rates across the entire yield curve. So why is there no inflation?
If we were to pick a year that we could call the big bang, I would choose 2008-2009. This period marked the first time that the incremental organic demand for global sovereign debt was less than the new supply. That period was so crucial to the global financial system, because for the first time bond supply overtook demand. Prior to the 2008 collapse, the elevated asset markets helped to keep demand for sovereign debt high enough. But as asset prices fell, the demand quickly fell behind supply, and the governments were confronted with a situation they had never faced before in modern history. Who was going to buy their debt?
If bond yields were to spike and inflation was to take hold as people like Martin Armstrong theorize, this would have been the time. But the central banks stepped in to save the day. Since it is clear that there will never be any debt “jubilee” and that all outstanding debts will remain due, the debt will always place a drag on the vitality of the economy. All this debt, regardless of who holds it, needs to be serviced. This creates a massive deflationary force as the economy struggles to pay the interest and the growing principal amounts as they come due.
There is only one way to save yourself from lower rates
It doesn’t matter if rates are low, or even negative. The principal remains and grows mightily as the central banks buy up all the extra supply that the global investors cannot absorb. There will be no government bankruptcies with debt forgiveness and the amount of U.S. Treasuries can grow forever. The Fed will buy it all up.
So, the governments have found the answer to all the calls for balanced budgets. They don’t have to worry anymore; they can spend as much as they want and inflation won’t grow. In fact, with the central banks buying up all the extra supply, inflationary forces will diminish over time. Sure, the asset markets will rage higher as the monetary equivalents of sovereign debt skyrocket in amount, but that money stays in the financial shell and will help to raise asset prices over time.
With low inflationary pressures from this deflationary red ink and free movement of input factors across national borders, interest rates can stay low and move lower. For those who understand this system and own the assets, it will feel like paradise.
Negative rates do not get these nations off the hook. Their amount of outstanding debt principal will spiral much higher than from what any negative rate may shave. In addition, the 10-year UST may one day be yielding -1.0%, but that could be in a world of -2.0% inflation, so the real burden will always grow. The only people who win in a regime of falling rates are the asset holders. Joe-Six Pack takes the bath as taxes and debts rise higher for him, while he has no offsetting assets.
Richard Clarida, the Fed Vice Chair knows exactly why inflation is low. He knows it’s low for the same reasons I am saying. The world is sinking in a sea of deflationary red ink and there is absolutely no hope for an escape. I don’t care how low rates go, we will all die on a global debt plantation. The only ones who will survive the longest will be the ones who own the income-generating assets.