The first two outcomes are the mainstream economics of financial markets. But the third possibility – based on an alleged loss of confidence in the government’s ability to make good on its key policy options – is the most dangerous aspect of recently rising bond prices. In this particular case, markets seem to be betting on the failure of unrealistic promises made by an administration left twisting in the wind by its Congressional majority.
The former Wall Street operatives working for the administration should be aware of an urgent need to reassure the markets about the economic agenda and the progress – if any – in its implementation. They should also realize that concrete and deliverable measures to improve jobs, incomes, health care and education are the best channels to connect with the American people, raise the approval ratings and fight alleged attempts to paralyze the executive authority.
Instead of that, the monetary policy is stuck with the best-case scenario of a 2 percent economic growth for the rest of the year, and beyond, and an inflation rate within the target range of 0-2 percent. In its apparent anticipation of no help from fiscal, trade and structural policies that is the best the Fed alone can do to keep the economy afloat for the seventh consecutive year.
That is probably also why the Fed has not been doing much to shrink its bloated balance sheet.
At the end of May, the monetary base stood 6.9 percent above its December 2016 level. During the same period, excess reserves (i.e., loanable funds) of the banking sector soared 9.6 percent to a staggering $2.1 trillion.
Lending to consumers remains brisk and sustained. The total credit extended to consumers in the year to March was growing at an average annual rate of 6.3 percent. Commercial banks account for 40 percent of that total, and their lending to households, over the same interval, marked a 7 percent increase.
In view of that, it makes little sense to get excited about future credit tightening speculations. The last 25 basis point increase in the federal funds rate still leaves the only interest rate the Fed directly controls at a negative -0.74 percent in real terms. That is a very easy credit stance indeed.
Assuming an inflation rate (measured by the CPI) of about 2 percent, it would take four additional interest rate increases of 0.25 percent to roughly reach the area of neutral monetary policy.
So, yes, the Fed is soldiering on, but the U.S. economy will underperform as long as it continues to move along solely on monetary policy and a woefully unbalanced policy mix.
The Fed, therefore, may wish to temper its “mission accomplished” enthusiasm. Exulting about a 4.3 percent unemployment rate and “tightening labor markets” is inappropriate. With 40 percent of active civilian labor force out of the market, and 13.6 million people — double the officially reported number – without a job, or stable employment, tightening labor market claims are specious and insensitive.
There certainly can be a lack of skilled labor in some industries, but with these numbers of excess supply there cannot be any tightening of the overall labor market. If that were the case, labor costs would be rising instead of declining. Last year, nominal hourly compensations decreased to 2.5 percent from 3 percent in 2015, marking a further weakening in the first five months of 2017.