Today is one where all eyes will be on New York at 7 pm UK time today. This is because the US Federal Reserve will announce its latest decision on interest-rates and via its Forward Guidance has raised expectations of an interest-rate rise. This would be its first of the credit crunch era and in fact the first change in trend for more than a decade as it was 2004 when it last voted for what became a series of interest-rate rises. Makes you think doesn’t it? Also I make the point on here from time to time that interest-rates have been in their own secular decline for quite some time which I shall illustrate with a very long-term chart of US bond yields and thanks to Barry Ritholz for it.
What this shows is that panics have been quite common really on a longer-term perspective and that there was a time before the US Federal Reserve. But my main point is that since 1981 there have been ebbs and flows in crises that seemed important at the time but Status Quo summed up the trend for interest-rates.
Down,Down Deeper and Down
Accordingly there are very few people around who were actively trading and dealing when the trend in the 1970s was from Yazz.
The only way is up baby.
Thought for thought and this is why the central banking mantra is this as expressed in Hit Me Baby One More Time fashion by Bank of England Governor Mark Carney yesterday in evidence to the UK Parliament.
The path of Bank Rate is much more important than the precise timing of the first increase, however…… I expect Bank Rate increases, when they come, to be gradual and limited to a level below past averages.
He returned to this subject later on.
It also seems likely that the equilibrium interest rate, having been sharply negative during the crisis, will move only slowly back up towards historically more ‘normal’ levels.
If you look at the long-term chart I have presented above it is hard not to have a good laugh at Governor Carney’s definition of “normal”. But he means that he expects UK Bank Rate to rise to around 2.5% which is about half of what was considered for a while to be normal for the UK as the NAIRU was considered to be around 4.5%. Non Accelerating Inflation rate of Unemployment in case you were wondering but do not disturb yourself too much as it is best forgotten and left in some backwater.
The Impact of “Open Mouth Operations”
This is where central bankers promise something under what is called Forward Guidance. In the UK and US this has involved promises of higher interest-rates but so far it has involved false starts with the US markets starting to price interest-rate rises towards the end of last year. This was because in her first press conference Fed Chair Janet Yellen gave a timescale of six months after the end of Quantitative Easing.
So what was supposed to be a guided path has had several misfires but the markets are like Pavlov’s Dogs these days as they await the next central banking handout and we have seen moves in two main areas.
The US Dollar
It must be living in the United States that prompted Bank of England policy maker Kristin Forbes to point this out last week and the emphasis is mine.
Sterling’s effective exchange rate has appreciated 17% since its recent trough in the spring of 2013. The U.S. dollar has appreciated by about 20% over the same period, while the euro has weakened by 7%.
If it was the UK then it would be equivalent to a 5% rise in interest-rates but the US is much more insular so let me say certainly 1% and maybe a bit more. The exact cause is a combination of perceived economic improvement and Forward Guidance which of course interrelate.
Let me jump to something which the European Central Bank has released this morning in its monthly review.
the outlook for real GDP growth has been revised down, primarily due to lower external demand owing to weaker growth in emerging markets.
Now if it is feeling that with a lower Euro what must US exporters be feeling with a higher level for the US Dollar? I think the interest-rate rise equivalent is pushing well above 1% now.
These have been rising over the past month or so with the US Treasury Note (10 year) yield rising from a nadir of 2% to 2.28% as I type this. The US 2 year yield has risen proportionately more from 0.57% to 0.8%. Whilst this may not be much in terms of the chart above it means that is now yields more than the German ten-year. That would be a trade which would have some excitement today would it not?
Also we have something of an illustration of the world power of the Federal Reserve as bond yields in general have risen over this time.
Other central bankers have gone out of their way to express fears over the immediate outlook. From Bank of England Governor Carney.
Actual headwinds to UK growth could grow if a potential further material slowing of growth in China and more broadly in emerging markets materialises.
From the ECB this morning.
Notably, current developments in emerging market economies have the potential to further affect global growth adversely via trade and confidence effects.
What about inflation?
Yesterday we were told this by the US Bureau of Labor Statistics.
The all items index increased 0.2 percent for the 12 months ending August, the same increase as for the 12 months ending July.
So it is a full decimal point away from the target. Even worse in this context is the fact that it uses a measure (PCE Inflation) which tends to be some 0.4% or so lower than this.
So we can see that as the oil price fall washes out of annual comparisons there will be a rise but enough to go above target? Certainly nowhere near the position back in 2004 (H/T @moved_average).
YoY CPI 0.2%..last time Fed raised in ’04 …3.3%
Like the UK the United States is seeing a bit of a pick-up as yesterday’s data contained this too.
Real average hourly earnings for all employees increased 0.5 percent from July to August……This increase in real average hourly earnings combined with a 0.3-percent increase in the average workweek resulted in a 2.3-percent increase in real average weekly earnings over this period.
However a counterpoint to this has been published by the Census Bureau.
In 2014, real median household income was 6.5 percent lower than in 2007, the year before the most recent recession…… and 7.2 percent lower than the median household income peak ($57,843) that occurred in 1999.
Poorer this century? Well we know why interest-rates have continued to fall then..
Also my argument that there is a road to negative interest-rates gets a tick as I note that the last 3 years of “recovery” have made no statistically significant change.
Much remains to be done about poverty too.
In 2014, the official poverty rate was 14.8 percent. There were 46.7 million people in poverty……The 2014 poverty rate was 2.3 percentage points higher than in 2007, the year before the most recent recession.
There is much to consider here and let me start with a more philosophical question. Is this the end of inflation targeting? I have raised this question before and the issue is whether it is possible in the credit crunch era to look a couple of years ahead? In my opinion the answer is no. On this road looking at the Census Bureau numbers we also have the issue of what is a recovery?
Such thoughts are the ones which in my opinion are likely to stay the hand of the Federal Reserve this evening. Central bankers are pack animals and we have seen what the Bank of England and ECB think. If a rise went wrong the Federal Reserve would run the risk of looking very foolish and would undo what they consider to be years of work and success. Oh and every central bank that has raised interest-rates in this fashion in the credit crunch era has then subsequently cut them!
Songs for an interest-rate rise
Just in case I would not want to miss out.
The Only Way Is Up by Yazz
Higher and Higher by Jackie Wilson
Move On Up by Curtis Mayfield
Start Me Up by the Rolling Stones
Coming Up by Paul McCartney and Wings
Or if you feel like a break
Wake Me Up When September Ends by Green Day
More suggestions are welcome…..