How much will interest-rates rise?

The issue of interest-rate rises has suddenly become something of a hot topic and let me open with the words of Jamie Dimon of JP Morgan. From the Financial Times.

Jamie Dimon, head of JPMorgan Chase, has warned that the US economy is at risk of overheating, raising the prospect that the Federal Reserve may soon need to slam on the brakes to prevent wages and prices from rising too quickly.

There are more than a few begged questions here but let us park them for now and carry on.

“Many people underestimate the possibility of higher inflation and wages, which means they might be underestimating the chance that the Federal Reserve may have to raise rates faster than we all think,” he wrote. “We have to deal with the possibility that, at one point, the Federal Reserve and other central banks may have to take more drastic action than they currently anticipate.”

Okay let us break this down. Firstly we are back to output gap theory again which of course has been wrong,wrong and wrong again in the credit crunch era. If there are signs of overheating then they are to be found in asset markets where we have seen booming bond prices and house prices and until recently all-time highs for equity markets. Only on Tuesday we looked at US house price growth of 6% or 7% depending which data you use.

Wages

I have picked this out because there has been quite a swerve from Jamie Dimon as for so long nearly everyone has been hoping for higher wages. Now suddenly apparently a rise is a bad thing? The Financial Times article implicitly parrots this line.

The prospect of an overheating economy has spooked the financial markets as recently as February, when stronger-than-expected US wage growth sparked the worst Wall Street sell-off in six years.

In terms of numbers a rise in average earnings growth per hour to 2.9% was hardly groundbreaking and of course it has since faded away showing the unreliable nature of one month’s data. In reality to return to old era trends we would need wages growth of 3.5%+ for a while. But in Jamie’s world that seems to be a bad thing although apparently not always. From Bloomberg.

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon received $29.5 million in total compensation for his work in 2017, an increase of 5.4 percent from a year earlier.

So we are left mulling a view where what was supposed to be good would now be bad! Although those of you who in the comments section have argued we will not see major interest-rate rises until wage rises for the ordinary person picks up are permitted a wry smile at this point.

What is expected?

From the FT article.

Prices of Fed funds futures suggest few expect the Fed to raise rates by more than three times this year, as policymakers have indicated. Longer-term market measures also indicate that investors expect inflation and bond yields to remain subdued for years to come.

I put the second sentence in because it is positively misleading. What those measures are provide a balancing of markets now and usually have very little to do with what will happen. Returning to interest-rates we got a view this week from former Federal Reserve Chair Janet Yellen.

At Monday’s larger forum for Jefferies clients, she expressed the view that three or four rate rises were likely this year, and that recent U.S. tax cuts and a boost in government spending posed at least some risk of running the economy hot, according to the first source, who requested anonymity. ( CNBC)

This is the awkward bit about the Jamie Dimon claim which is that the existing and likely moves in US interest-rates are a response to expected higher inflation anyway as of course as we have looked at many times it is still below the target. Back to Janet.

Later, over dinner at the Manhattan penthouse of Jefferies’ chief executive, Yellen told executives from hedge funds, private equity firms and other companies that she considered inflation to be in check and unlikely to spike, so rates would stay relatively low, according to a second person familiar with the discussion.

Take that as you will as of course we discovered in her time that she does not really understand inflation.

The Bank of England

So how will it respond as traditionally it follows the US Federal Reserve?

We’re pleased to announce that singer-songwriter will be joining us for a event on 19 April, delivering his talk ‘The Struggle for Accountability in the Digital Age’ followed by a Q&A. Find out more and apply for free tickets.

Oh sorry not that one. Let us move onto its favourite publication the Financial Times.

Policymakers at the Bank of England are debating whether to be more forthcoming about their future plans for interest rates, as they gear up for a crunch vote on the cost of borrowing next month.

This is fascinating stuff because it both implies and suggests they know what their forecasts are! Let me give you an example reviewed favourably by Chris Giles the economics editor of the FT.

But last month Gertjan Vlieghe, an external MPC member, broke ranks with his colleagues on the nine-member committee when he said that rates could rise above 2 per cent over the same period.

Actually if we remove the rose-tintin ( sorry but he is Belgian) he seems an excitable chap as this from the Evening Standard in April 2016 reveals.

Vlieghe’s answer is intriguing: “Theoretically, I think interest rates could go a little bit negative.”

The long discussion on negative interest-rates that took place was clearly a hint of expected policy and means that Gertjan was wrong which poses a question over why we should listen this time? Although Chris Giles has a very different view.

Not sure it matters if people believe them.

I think it matters a lot. Oh and as the Swedish Riksbank has found it.

The Riksbank has had some difficulties with its predictions.

But to be fair Chris Giles does have a sense of humour ( I think).

But there remains concern that the BoE could undermine trust in it as an institution running an important public policy if it makes predictions about interest rates that do not come to pass.

Comment

Let me open with a rather good reply to this from GreaterFool.

Any shreds of credibility that the BoE once had disappeared into smoke after the forward guidance experiment. Telling people that you’ll raise rates after unemployment falls below 7% and then dropping them again when unemployment is below 5% will do that.

In fact the hits keep coming as though in this instance from Felix2012

There are quite a few commenters here who still take MPC seriously, unfortunately.

As to clarity well we did get that from Governor Carney back in June 2014.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced….“It could happen sooner than markets currently expect.

That was taken as a clear signal back then and the next day saw a lot of market adjustments which later led to losses as it never happened. Of course the road to a Bank Rate cut after Governor Carney hinted at it was both real and fast as we discovered 3 years later.

So what can we expect? The Bank of England has rather committed itself to a May Bank Rate rise which if you look at falling inflation and some weaker economic news looks out of touch. We have seen signs of slowing in Europe too as German industrial production has shown already today. The US Federal Reserve will no doubt carry on course unless there is a shock stateside although not everyone even thinks we need any tightening. BoI is the Bank of Italy.

 

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30 thoughts on “How much will interest-rates rise?

  1. Shaun, thanks for continuing to shine a spotlight on this area, my sweep stake option is for no change to rates in May given recent economic news. I think the BoE panel are scared of being blamed for any adverse news so doing nothing allows them to avoid any responsibility.

    With regards Jamie Dimon, if everyone got a pay rise and inflation picked up, his 5.4% increase would be eroded and we can’t have that.

    • Hi DoubtingDick

      The panic Bank Rate cut of August 2016 has left the Bank of England in a mess. Even they realise interest-rates should be higher ( I think) but they missed the chance to raise them ahead of the inflation rise. Now they seem to be keen to raise them when inflation is on the way down and there are weaker economic signals both here and in Europe.

  2. Hello Shaun,

    I predict the Face of BoE will raise interest rates based on the rise in wages .

    RPI/CPI is not cared about and indeed increases there whilst wages stagnated or fell
    was ” necessary ” ……

    so having cornered himself , a small increase , no more than 0.25% and maybe a token 0.1%

    but as they say, prediction is difficult , especially about the future !

    Forbin

    • Hi Forbin

      I like the idea of them being so unsure and indecisive that they only raise Bank Rate next month by 0.1% to 0.6%. After all they planned to cut by 0.1% in November 2016 to 0.15% before it got abandoned due to another forecasting failure.

  3. The US is only putting up rates so they’ve room to drop them significantly when the next downturn occurs … imho Carnage is hoping this downturn will happen sooner rather than later so he doesn’t have to raise as it’ll not be in the interest of his precious bubble that has enriched his family and friends wealth rather handsomely.

    Still they’re all paid an absolute fortune if the continue to screwing things up and they’ve no one to answer to so it doesn’t really matter to them what the outcome is.

    • Hi Arthur

      There was a Bank of England Working Paper at the end of last month on the distributional effect of QE. Here is the crux of it.

      “Reflecting the pre-existing disparities in income and wealth, we find that the impact on each household varied substantially in cash terms across the income and wealth distributions, but in percentage terms, the effects are estimated to have been broadly similar. ”

      “varied substantially” means you were right in your comment…

  4. Great blog as usual, Shaun.
    You may be interested in the views of David “Get Out of” Dodge, Mark Carney’s mentor and immediate predecessor as Governor of the Bank of Canada on the subject from an interview published April 4: “I’ve been quite clear, starting in 2016, that in both Canada and the U.S., the central banks should have been slowly raising rates and indicating they were going to have to continue to raise rates to whatever the new normal is—say, 3% – in a fairly consistent and predictable fashion.” The odd thing is that Dodge:
    1) Would only replace the existing inflation targeting regime by a price level targeting regime, if at all,
    2) Would not lower the 2% inflation target,
    3) Thinks that asset prices in an inflation measure are anathema (who do you think Carney acquired his views from?) so would have had no use for the Eurostat pilots to include an owner-occupied housing component in the HICP that were ongoing in the seven years he served as Governor of the Bank of Canada, but he seems to have been blissfully ignorant of them.

    In other words, absolutely nothing in what he regarded as an appropriate framework for monetary policy would have dictated a bank rate hike by either central bank. Quite the contrary, a price level targeting regime would have been bent on lowering the bank rate to push the inflation rate above 2% to make up for consistently missing the 2% target most of the time for so many years. His recommendations for monetary policy are dramatically at odds with his recommendations for a policy framework.

    I would have bet a lot of money that 23-year old Bruce Mouat’s Scottish team would not be at the top of the standings going into the final day of the round robin of the men’s world curling championships in Las Vegas, or that his team would lose to the reigning world championship team from Canada in the round robin. I would have lost both bets. Whatever happens over the next three days Mouat’s team has already done Britain proud.

    • Hi Andrew and thank you

      I was unaware of the curling as there is so much sport going on so thank you and good luck to Canada in the Commonwealth Games. I found a non-paywalled link to the speech you mention and for me this is the crux of the matter for Mr.Dodge.

      “The BIS analysis shows that Canada is among a very small group of countries where the ratio of household debt to GDP not only exceeds 100 percent today but also has been rising steeply since the 2008 crisis. Canadian household debt has increased from 79 percent of GDP in 2007 to an estimated 101 percent in 2017. Moreover, almost half of this debt is owed by households in the bottom 60 percent of the income distribution. Households in Canada today, even with current low interest rates, devote a higher fraction of their income to interest payments than they did before the financial crisis.”

      Re-Rewind?

      • Of course, you are right. They do only represent Scotland. In the Winter Olympics another Scottish team represented Great Britain. I assume it was GB rather than the UK because while there are curling clubs in GB outside of Scotland there are none, for the moment, in Northern Ireland, but I am just guessing. I wrote what I did because I would assume British people take pride in outstanding performances by athletes from any of their Home Nations on the international stage. I am happy when a Quebec athlete representing their province does well at the Francophone Games. Anyway, best of luck to the Bruce Mouat team this weekend.

        • Sorry to be pedantic, but I come from a small country which, for many reasons, including the self-confidence of it’s population, needs all the recognition it can get.

  5. One by one the old cannards of economics are dying Noah Smith (@noahopinion) had a great article up on the fact that supply and demand no longer explains wage rates. Then many went on to explain that in fact supply and demand explains nothing at all. Money printing causes inflation… Really? Low employment = high inflation… Really? Crowding out, lump of labour, finite money, the bond monster all now utterly disproven concepts.

    The trouble is the BoE, Fed, IMF et al still act as if these concepts were things, no wonder their predictions tend to err from the slightly wrong to the outlandishly wrong.

  6. Shaun,

    BoE interest rates are irrelevant for most citizens if current loans, credit card and payday loan rates are considered.

    I suggest inaction by the MPC will result in savings rates reducing in an attempt to finally get savers spending and to allow wiggle room if rates ever increase.

    • Hi chris

      One of the replies to the FT article pointed out how little had changed since the November Bank Rate rise and suggested that little would until it went above 1%. Looking back over the period where Bank Rate fell by 4% or so then credit card interest-rates rose by 2%.

  7. Hi Shaun

    The BOE have been between a rock and a hard place for years. ZIRP has pumped up asset prices to absurd levels but putting up interest rates to anywhere near reasonable levels will bring down the whole debt riddled house of cards.

    This situation will not heal of its own accord; the almost pathetic deemed necessity to avoid any sort of pain or adjustment is simply compounding the problems and means that any problem now will get worse until the point of collapse. The Austrian school would say that purges are necessary to eliminate inefficient producers (Schumpeter’s gales of creative destruction) and that the normal Keynesian solution, by trying to avoid this process, simply creates a situation where inefficient producers continue to survive and this leads to a gradual erosion in productivity generally and productivity is the source of prosperity.

    The incompetence of the BOE is not just the maladministration of economic policy but the undermining of one of our important institutions and this manifest stupidity does none of us any favours.

    • Hi Bob J

      In a way you are echoing Andrew’s point above. The former Governor of the Bank of Canada is implicitly admitting some of the mistakes made but will not explicitly say so. Thus we end up with talk of inflation rising and output gaps as a smokescreen for engaging reverse gear. Or the silliness of raising interest-rates now so that they can be cut later…..

  8. in other news it has been found there are dozens of black holes at the center of the galaxy

    the contest is now on to name them……

    I suggest FED , BOE , ECB, BOJ , etc assuming there is no direct connection already,…..

    Fobin

  9. Hi Shaun I read the FT article too, Dimon does seem to be connected to the trumpster so perhaps he knows what is coming. I would judge most CBr’s like a status quo of any kind so despite the unsustainablity of their IR treatment they cling to what they know – low rates. Any significant increase will be a black swan event for them. I agree with other commentators, BoE Carney now has an excuse to sit on his hands again in May this year.

    We are all waiting for their status quo to founder, the longer it runs the more problems it makes, your blog ably cites the economic consequences however the social problems are clearly mounting but not probably correctly attributed to low interest rates.

    – Lack of fair opportunity for young people in society
    – Hollowing-out of state provision with Housing Benefit pouring into landlord’s speculation
    – Homelessness as private landlords exit social tenants due to Universal Benefit
    – Homelessness as property investors hold empty homes for return
    – Poor & Declining Productivity per capita
    – Poor Wage growth leading to reliance on PayDay Loans and credit cards
    – Housing values used as a cash machine to promote debt consumption

    Thats a lot of blame on Mark Carney but clearly most adults are complicit from ignorance and fot reasons of self interest.

    Paul

    • As much as i despise Carney he was brought in to reinflate the debt/property bubble so the Tory party could win the 2015 election. So from that point of view he has done a good job. Its the Tory party who set the tune for the BoE to dance to.

  10. Very late commenting, Shaun, sorry. The Fed are increasing rates to stop a future asset price implosion , or at least to try to get a softer landing. They are finally doing something belatedly about the ‘bubbles’. Now you could be cynical and think that the timing might be coincidental with Trump’s presidency and who am I to possibly comment……

    • Hi Jim

      In essence that was the speech given by the former Governor of the Bank of Canada that Andrew refers to above. He had an interesting section on the Canadian/US differences.

      “But, despite the very high ratio of debt to income in Canada, I think the risk of financial turbulence and a future economic contraction due to rising inflation and interest rates in 2018 and 2019 is relatively low. On the other hand, even though American household debt relative to income is less stretched than in Canada, the BIS warnings of possible financial turbulence may have somewhat more salience in that country. Because U.S. authorities are set to ease regulatory restrictions on financial institutions, and because the federal government will deliver a very large dose of stimulus medicine through the recent tax cut, the current IMF forecast of U.S. growth of very close to three percent in each of 2018 and 2019 may actually be achieved and inflation may increase significantly. For the U.S., the lights warning of serious financial and economic turbulence ahead—turbulence far greater than a 10- or 15-percent stock market correction—are flashing yellow.”

    • Increasing rates WILL cause an asset price implosion in respect of houses/equities and indeed old bonds as investors sell everything in order to buy new treasuries to benefit from the new higher rates whilst stretched house holders will default on their mortgages creating an increase in supply of housing for sale so I have no idea where you’re coming from?

  11. Your point about the expected BOE May rate rise is well made as I said here in December 2016 that was the time to raise although the UK will still do better than the US or EU this year (I am talking a bout a tallest in class amongst a group of pygmies here).

    However, re:

    “…as of course as we have looked at many times it is still below the target.” ahem – https://www.federalreserve.gov/faqs/economy_14400.htm

    AND:

    https://tradingeconomics.com/united-states/inflation-cpi

    I suggest you recheck your figures Shaun. It may be that you are looking at a different information source for the inflation rate. If so please provide the link as I may form the opinion your source is more accurate than mine.

    Regards US wage rises they have been above inflation for some time and I guess it is this that causes the Fed concern – https://www.frbatlanta.org/chcs/wage-growth-tracker.aspx?panel=1

    This wage growth has not been matched by productivity growth thereby increasing the likelihood of wage push inflation: – https://tradingeconomics.com/united-states/productivity.

    So Jamie Dimon is in fact right at this point, but that’s only part of the story as we have yet to see how Trump’s tax cuts play out which we will not begin to witness until late this year. US narrow money growth in H2 last year was abysmal followed by, I suspect a downturn in the Kitcjhin cycle beginning last month, so there is a good chance that US economy growth will start to slow dramatically about now, far from overheating. In the full perspective Jamie Dimon is wrong but not for the reasons you imply.

    • Hi Noo2

      The answer is in the opening sentence of your first link.

      “The Federal Open Market Committee (FOMC) judges that inflation at the rate of 2 percent (as measured by the annual change in the price index for personal consumption expenditures, or PCE)”

      That is not the same as the US CPI inflation index and tends to be of the order of 0.5% or so below it. One of the reasons for this was conveniently explained earlier this week in the comments section by Andrew Baldwin.

      Anyway here it is.

      https://tradingeconomics.com/united-states/pce-price-index

      • Thanks for replying Shaun. It looks like the Fed’s PCE is broadly equivalent to the UK’s CPI and calculation of housing costs is the monkey in the room.

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