Markets are moving in dramatic fashion, obscuring the improving US economy. Or vice-versa. Our 10-year T-note fell to 2.08% Friday, mortgages attempting to crack 4.00%; the German 10-year is a new all-time low 0.627% joined by Japanās 0.398%. Stock markets are truly volatile, up-down-up-down. Oil has broken $60 and may go significantly lower as weaker producers are forced to pump more as prices fall.
Media commentary is badly confused trying to explain these events, the center line holding that falling oil will cause inflation to fall, therefore buying bonds makes sense even at ridiculous yields. However, core inflation is not falling. Central banks use core (excluding energy and food) because energy is so volatile; the drop in nominal inflation today is just the flip side of the energy-driven jumps in 2008 and 2013. Proper central banking should not react to either.
What is happening in Europe
Most commentary assumes the European Central Bank (ECB ) will begin its first real quantitative easing (QE) in January, buying sovereign bonds, and say that markets are front-running. Donāt bet on that. Stark fear is the mover in global markets: fear that deflation is out of control in both Japan and Europe, fear that Chinaās slowdown will pull the stool from under commodity producers and emerging nations, and fear that the oil price drop is more hurtful than stimulative.
Fear there, but not here! From 2007 until this year the US economy was fragile and accident prone. No longer. We are still limping in spots — incomes and housing — but now weāre resilient, headwinds diminished and fewer open manholes.
The Fed is correct to plan liftoff from the ā0%-.25%ā of the last six years. Home mortgage credit rose in the last quarter for the first time in eight years. Total bank credit had a great year, rising 9% annualized until plopping in half in October, but in November ran a 14% pace. Retail sales are fine. The small-business survey by the National Federation of Independent Business (NFIB) in November jumped from its six-year trench.
Lower oil prices are a help here, but not as much as in any prior drop. Natural gas prices have been down for five years. Electricity generated by burning oil has dropped 88% since 2013, replaced by gas and renewables. This is a gasoline-only deal: $2.50 will help, but miles driven have fallen ever since we rose above two bucks.
We have a precedent for this situation, US gaining strength, the rest of the world a mess. 1997-98 was the āAsian Contagion,ā a global credit/currency meltdown concluding in default by Russia. The Fed was panicked that the US was the only growth engine, and if we faltered… no way out. So the Fed cut its overnight rate and with hindsight was dead wrong. The weakness overseas helped US strength, capped inflation here, and exactly as today pushed a flood of cash to US bonds, driving down mortgages and other borrowing costs. The Fedās easing then did nothing but add air to the stock market bubble, and quick reversal of excessive stimulus led directly to recession.
Today, the Fed need not worry about inflation, but it absolutely should worry about the potential for hidden bubbles caused by the zero-percent regime. At zero it is at least 1.5% below inflation, highly stimulative, and zero is unnatural.
The Fedās tightening this time may look like no other. Raising the overnight cost of money will push the dollar higher and overseas cash will continue to pour into our bonds and mortgages. Fed liftoff may have no effect at all on long-term rates, which might even continue to fall. The principal reason for the Fed not to tighten is the continuing weakness of housing, but we may be unscathed.
You can bet the most important thing the Fed will watch after liftoff will be long-term rates. If they rise, the Fed will slow or stop altogether; if no effect, the Fed may jack the Fed funds rate fairly rapidly. Imagine in 2016 a 2.00% Fed funds rate and a 2.00% 10-year, and such convergence or even inversion (short over long) not a sign of recession, just domestic strength and foreign desperation for yield!
Risks now are overseas. Markets show signs of destabilization, but thus far only reinforcing the flows of cash to us. Those flows will not stop until recovery over there, which is a hell of a lot closer to āifā than āwhen.ā
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US 10-year T-note in the last year. One week ago it looked as though the downtrend had broken. One violent week and itās intact:
Oil in the last year. Venezuela will default on its debt, and Junior Stalin will have some explaining to do at home:
Speaking of Czar Vladimir, the ruble is entering catastrophic terrain (scale inverted, rubles/dollar):
Retail sales this summer appeared in a multi-year downtrend. Not:
An authentic improvement:
Limited however to expectations, not current results:
Small business is the great US engine of jobs, ever-so-slightly better, but not yet perky:
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