In “Uncle John’s Band”, the Grateful Dead sing: “‘Cause when life looks like easy street, there is danger at your door”.
Many marketplace generals nowadays have faith that rising United States government interest rates reflects both sustained adequate American economic growth and the likely development of inflation sufficient to satisfy the Federal Reserve Board’s two percent yardstick. In addition to GDP growth and rising inflation and inflation expectations, observers also should focus on other issues and their consequence for assorted marketplace trends and relationships.
Viewpoints of natural (equilibrium, fair or true value, normal, average, appropriate) prices and price overshooting or undershooting (expensive, cheap; too high, too low) reflect subjective opinions, not science. In any case, relatively few observers ask whether the Federal Reserve guardian will permit inflation benchmarks to exceed for a relatively long time (and somewhat decisively) its adored two percent signpost. Such overshooting by notable inflation variables will tend to propel government yields higher than many expect. The US Consumer Price Index (CPI-U) jumped 2.5 percent year-on-year in January 2017. Will personal consumption expenditure (PCE) inflation also overshoot the Fed’s two percent target?
The Fed likely will tolerate inflation target overshooting for some time because it wants to be confident that the achievement of its inflation goal will be durable. Such an indulgent policy regarding overshooting still permits the Fed to engage in gradual increases in policy rates (Federal Funds), especially as asset prices (such as American stocks and real estate) have soared since their dismal global economic crisis lows and as the prospective US fiscal outlook appears rather expansionary (and even overly stimulative).
Also, trust in the ability of the Fed and its allies such as the European Central Bank to manage inflation is widespread. How many audiences worry whether the years of devoted yield repression have created a reservoir of pent-up inflation, which the Fed’s gradual rollback of accommodation (permitting higher Federal Funds and government rates) will unveil and reflect?
America has a substantial public debt. Not much attention focuses on the likelihood and implications of growing American federal budget deficits, even without any legislative changes, over the next decade and beyond. See the US Congressional Budget Office’s “The Budget and Economic Outlook; 2017 to 2027” (1/24/17), as well as “Federal Debt and the Statutory Limit” (3/7/17). According to the NY Times (3/10/17, pA21), on 3/13/17 the CBO is expected to release its judgment on the proposed House Republican legislation, the American Health Care Act, aiming to repeal and replace the Affordable Care Act (Obamacare).
Moreover, the media, politicians, and Wall Street have spent much attention on President’s Trump’s potential tax “reform” and express hope regarding his misty infrastructure plans. But not many pundits stress that Trump’s tax scheme (even without reference to Obamacare), if enacted, likely will cause massive rises in budget deficits. The Fed may elect to raise rates more quickly (aggressively) than some predict if Congress adopts much or all of the fiscal scheme of Trump and his comrades. In any case, most people do not ask how enthusiastic foreigners (who own a huge slice of Treasury debt) will be to keep financing growing budget shortfalls. The Fed sheriff, unlike the European Central Bank and Bank of Japan, is no longer wedded to quantitative easing (securities purchasing tied into money printing), so it will not rush to add many UST obligations to its balance sheet.
Also, all else equal, substantial questions regarding national leadership quality can undermine both political and economic confidence in that nation. This situation can encourage higher interest rates, a weaker currency, or both. Donald Trump lacks government insider experience. Domestic and international faith in his political leadership ability (and in the US Congress as a whole) is not high. In the film “Easy Rider” (director Dennis Hopper) a character underlines that “it’s real hard to be free when you are bought and sold in the marketplace.”
Fierce, widespread, and substantial ongoing partisan political (economic) divisions likewise risk weakening America’s currency and promoting increased government interest rates. Trump’s victory did not unite an already significantly divided America. In America, there are liberals (progressives) and conservatives (traditionalists). Populists (both left and right wing) confront the establishment (elites). Globalists contend with nationalists.
Trump’s “Make America Great Again!” and “America First” slogans and many of his policy pronouncements obviously appeal to large numbers of Americans. However, they do not attract or inspire many (and arguably a majority of) citizens. Though both the House and Senate are Republican-controlled, not all Republicans warmly support Trump and his policies. Although Trump triumphed in the Electoral College, he decisively lost the popular vote tally. The popular vote outcome obviously reflects America’s sharp political divisions. Also, the Russian President “directed a vast cyberattack aimed at denying Hillary Clinton the presidency and installing Donald J. Trump in the Oval Office, the nation’s top intelligence agencies said in an extraordinary report” (NYTimes, 1/7/17, ppA1, 11). Trump’s popular vote defeat and the report on Russian political interference undermine Trump’s political “legitimacy” (faith in it) and thus his ability to lead effectively.
America has other substantial splits and fractures. It has rich versus poor, haves versus have-nots. Look at the nation’s substantial economic inequality. Consider divisions relating to race (ethnicity), gender, religion, age, geographic region, and urban/rural. Fiery quarrels rage over tax and spending policies and priorities, health care (Obamacare), trade policies, the appropriate degree of economic regulation, abortion rights, gun ownership, and environmental issues such as climate change.
With such ongoing, wide-ranging, and seemingly intractable American divisions and related passionate debates and accusations, worries increase regarding “how anything (good; productive; necessary) can get done”. Escalating doubts relating to leadership and concerns regarding the consequences of persistent divisiveness can encourage growing fears at home and abroad regarding the nation’s current and potential political and economic outlook. This horizon consequently may not necessarily encourage a “flight to quality” by buyers into the government debt securities of that country. Instead, particularly when inflation also is increasing and budget deficits likely will rise, low (deteriorating) confidence can spur interest rate rises.
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Easing Comes, Easing Goes- US Government Interest Rates (3-13-17)