The Fed risks raising interest rates too much as the compass spins wildly<\/h3>\n![\"\"](\"https:\/\/stateofthenation2012.com\/wp-content\/uploads\/2018\/10\/MW-GR631_north__20181011153157_ZH.jpg\")
<\/a>Stars appear to rotate around Polaris, the North Star, in this time exposure of the Kitt Peak National Observatory near Tucson, Ariz.<\/p><\/div>\n
By Peter Morici
\nMarketWatch<\/p>\n
Federal Reserve Chairman Jerome Powell is in an unenviable position. Folks expect him to fine-tune interest rates to keep the economy going and inflation tame but he can\u2019t make things much better \u2014 only worse.<\/p>\n
Growth is nearly 3% and unemployment is at its\u00a0lowest level since 1969<\/a>. What inflation we have above the Fed target of 2% is driven largely by oil prices and those by forces beyond the influence of U.S. economic conditions \u2014 OPEC politics, U.S. sanctions on Iran, and dystopian political forces in Venezuela and a few other garden spots.<\/p>\nWhen the current turbulence in oil markets recedes, we are likely in for a period of headline inflation below 2%, just as those forces are now driving prices higher now.<\/p>\n
Overall, long-term inflation has settled in at the Fed target of about 2%.\u00a0The Fed should not obsess\u00a0<\/a>about it but keep a watchful eye.<\/p>\nAmid all this, Powell\u2019s inflation compass has gone missing.\u00a0The Phillips curve<\/a>, as he puts it, may not be dead but\u00a0just resting.<\/a>\u00a0To my thinking, it\u2019s in a coma if it was ever alive at all.<\/p>\nThat contraption is a shorthand equation sitting atop a pyramid of more fundamental behavioral relationships. Those include the supply and demand for domestic workers and in turn, an historically large contingent labor force of healthy prime-age adults sitting on the sidelines, the shifting skill requirements of a workplace transformed by artificial intelligence and robotics, import prices influenced by weak growth in Europe and China, and immigration.<\/p>\n
Of course, Mariner Powell has his North Star \u2014 what economists affectionately call R* (R-Star), but it is no longer at a fixed position in Powell\u2019s sky.<\/p>\n
R* is the\u00a0federal funds rate\u00a0<\/a>that neither encourages the economy to speed up or slow down. However, with\u00a0businesses needing much less capital\u00a0<\/a>to get started or grow these days and for decades China and Germany\u2014the second and fourth largest economies globally\u2014racking up current account surpluses and savings to invest abroad, it is no wonder the forces of supply and demand have been\u00a0driving R* down to historically low levels<\/a>.<\/p>\nWith long-run inflation at 2%, current estimates put the nominal R* at a bit below 3%. That\u2019sjust three more quarter-point rate increases<\/a>\u00a0away.<\/p>\nOvershooting could kill the recovery but how is Powell to know?<\/p>\n
Miner Powell\u2019s canary has gone AWOL. Historically, economists and financial types have looked to the yield curve for the warning croak that the economy is headed for recession.<\/p>\n
When I wrote about\u00a0a flattening yield curve\u00a0<\/a>on MarketWatch early last December, the 10-year\u00a0TMUBMUSD10Y,\u00a0+0.24%<\/span><\/a><\/span>\u00a0\u00a0less 30-day Treasurys\u00a0TMUBMUSD01M,\u00a0+0.23%<\/span><\/a><\/span>\u00a0\u00a0spread was about 120 basis points. Now\u00a0it\u2019s about 100<\/a>, and\u00a0folks are even more nervous.<\/a><\/p>\nAlthough the gap is supposed to tell us about investor expectations for growth\u2014a wide spread meaning optimism and a narrowing gap the threat of recession \u2014 these days, long rates are significantly affected by factors quite beyond the U.S. economy.<\/p>\n
Increasingly, the dollar\u00a0BUXX,\u00a0+0.02%<\/span><\/a><\/span>\u00a0\u00a0 is the currency of payment for import contracts \u2014\u00a040% of imports worldwide are invoiced in dollars<\/a>\u00a0even though the United States is only about one-tenth of the market. And populist movements in Europe and political uncertainty elsewhere have\u00a0driven private-asset managers and savers into dollars<\/a>. Consequently, foreign private actors \u2014 not just foreign central banks \u2014 have a ravenous appetite for Treasurys and dollar-denominated deposits.<\/p>\nThe economists at the Fed are really econometricians bent on estimating all these relationships with ever-more-complex statistical techniques but they only have historical data. The parameters keep shifting, and historical information can only inadequately tell us their values.<\/p>\n
All the Fed can do is feel its way with an eye toward price pressure in the core. In the 1950s, we hit unemployment below 3%, and it could go much lower than 3.7% without much inflation.<\/p>\n
We have strong reason to believe the equilibrium short-term rate is no more than 3% \u2014 though on that\u00a0Chairman Powell is agnostic<\/a>. And if we take Federal Open Market Committee\u00a0policy statements and the plot chart<\/a>\u00a0at face value, Powell and his colleagues intend to drive the federal funds rate to well above that by 2020.<\/p>\nThat\u2019s dangerous stuff.<\/p>\n
<\/a>Stars appear to rotate around Polaris, the North Star, in this time exposure of the Kitt Peak National Observatory near Tucson, Ariz.<\/p><\/div>\n
By Peter Morici
\nMarketWatch<\/p>\n
Federal Reserve Chairman Jerome Powell is in an unenviable position. Folks expect him to fine-tune interest rates to keep the economy going and inflation tame but he can\u2019t make things much better \u2014 only worse.<\/p>\n
Growth is nearly 3% and unemployment is at its\u00a0lowest level since 1969<\/a>. What inflation we have above the Fed target of 2% is driven largely by oil prices and those by forces beyond the influence of U.S. economic conditions \u2014 OPEC politics, U.S. sanctions on Iran, and dystopian political forces in Venezuela and a few other garden spots.<\/p>\n When the current turbulence in oil markets recedes, we are likely in for a period of headline inflation below 2%, just as those forces are now driving prices higher now.<\/p>\n Overall, long-term inflation has settled in at the Fed target of about 2%.\u00a0The Fed should not obsess\u00a0<\/a>about it but keep a watchful eye.<\/p>\n Amid all this, Powell\u2019s inflation compass has gone missing.\u00a0The Phillips curve<\/a>, as he puts it, may not be dead but\u00a0just resting.<\/a>\u00a0To my thinking, it\u2019s in a coma if it was ever alive at all.<\/p>\n That contraption is a shorthand equation sitting atop a pyramid of more fundamental behavioral relationships. Those include the supply and demand for domestic workers and in turn, an historically large contingent labor force of healthy prime-age adults sitting on the sidelines, the shifting skill requirements of a workplace transformed by artificial intelligence and robotics, import prices influenced by weak growth in Europe and China, and immigration.<\/p>\n Of course, Mariner Powell has his North Star \u2014 what economists affectionately call R* (R-Star), but it is no longer at a fixed position in Powell\u2019s sky.<\/p>\n R* is the\u00a0federal funds rate\u00a0<\/a>that neither encourages the economy to speed up or slow down. However, with\u00a0businesses needing much less capital\u00a0<\/a>to get started or grow these days and for decades China and Germany\u2014the second and fourth largest economies globally\u2014racking up current account surpluses and savings to invest abroad, it is no wonder the forces of supply and demand have been\u00a0driving R* down to historically low levels<\/a>.<\/p>\n With long-run inflation at 2%, current estimates put the nominal R* at a bit below 3%. That\u2019sjust three more quarter-point rate increases<\/a>\u00a0away.<\/p>\n Overshooting could kill the recovery but how is Powell to know?<\/p>\n Miner Powell\u2019s canary has gone AWOL. Historically, economists and financial types have looked to the yield curve for the warning croak that the economy is headed for recession.<\/p>\n When I wrote about\u00a0a flattening yield curve\u00a0<\/a>on MarketWatch early last December, the 10-year\u00a0TMUBMUSD10Y,\u00a0+0.24%<\/span><\/a><\/span>\u00a0\u00a0less 30-day Treasurys\u00a0TMUBMUSD01M,\u00a0+0.23%<\/span><\/a><\/span>\u00a0\u00a0spread was about 120 basis points. Now\u00a0it\u2019s about 100<\/a>, and\u00a0folks are even more nervous.<\/a><\/p>\n Although the gap is supposed to tell us about investor expectations for growth\u2014a wide spread meaning optimism and a narrowing gap the threat of recession \u2014 these days, long rates are significantly affected by factors quite beyond the U.S. economy.<\/p>\n Increasingly, the dollar\u00a0BUXX,\u00a0+0.02%<\/span><\/a><\/span>\u00a0\u00a0 is the currency of payment for import contracts \u2014\u00a040% of imports worldwide are invoiced in dollars<\/a>\u00a0even though the United States is only about one-tenth of the market. And populist movements in Europe and political uncertainty elsewhere have\u00a0driven private-asset managers and savers into dollars<\/a>. Consequently, foreign private actors \u2014 not just foreign central banks \u2014 have a ravenous appetite for Treasurys and dollar-denominated deposits.<\/p>\n The economists at the Fed are really econometricians bent on estimating all these relationships with ever-more-complex statistical techniques but they only have historical data. The parameters keep shifting, and historical information can only inadequately tell us their values.<\/p>\n All the Fed can do is feel its way with an eye toward price pressure in the core. In the 1950s, we hit unemployment below 3%, and it could go much lower than 3.7% without much inflation.<\/p>\n We have strong reason to believe the equilibrium short-term rate is no more than 3% \u2014 though on that\u00a0Chairman Powell is agnostic<\/a>. And if we take Federal Open Market Committee\u00a0policy statements and the plot chart<\/a>\u00a0at face value, Powell and his colleagues intend to drive the federal funds rate to well above that by 2020.<\/p>\n That\u2019s dangerous stuff.<\/p>\n