Yields rose and stocks rose yesterday as encouraging data out of China coupled with better than expected home builder sentiment and of course, to make a trifecta you need something "AI" related in the news. In yesterday's case, the AI related news was that iPhone's may integrate Google's Gemini (yes the same one that everyone was complaining about the other week). The 2Y and 10Y yield are sitting around YTD highs at 4.74% and 4.33% respectively.
I wrote this before the BoJ, but maybe the day's excitement will be their first hike since 2007.
So while we wait for more exciting things, like the NCAA Tournament, and I guess the FOMC meeting (oh the suspense of the Dots), I thought I'd share some excerpts from recent economic related articles, all of which seem to imply that economist still have no clue about the current state of the economy and whether interest rates are restrictive.
Our first excerpt comes from the BIS and is on the natural rate of interest, r*. As a reminder "The natural rate refers to the short-term real interest rate that would prevail in the absence of business cycle shocks, with output at potential, saving equating investment and stable inflation. Hence, the natural rate serves as a yardstick for where real policy interest rates are headed. It is also a benchmark for assessing the monetary policy stance “looking through” business cycle fluctuations. It can be conceived of as representing the intercept in a monetary policy rule, as in a “Taylor rule” (Taylor (1993)). Together with the long-run inflation rate, defined by the central bank inflation target, it pins down the long-run level of the nominal policy rate." Now here's the interesting excerpts which to me ultimately conclude
- Moreover, and less often appreciated, monetary policy itself could have a non-negligible effect on natural rates and perceptions thereof, through debt accumulation and beliefs about r*. As such, the recent reemergence of upside inflation risks inducing a tighter monetary policy stance going forward may have pushed at least perceptions of r* higher
- The uncertainty around r* estimates at the current juncture is very high
- Some developments point to r* remaining at low pre-pandemic levels...trend real growth (though AI may boost that), increasing life expectancies.
- However, other developments point to a potential increase in natural rates...dependency ratios are increasing, fiscal deficits ballooned, the adoption of new technology requires increased investment and geopolitical fragmentation could reverse the global savings glut.
- Some recent studies point to the possibility that expansionary monetary policy may raise r*. Long-lasting positive effects on aggregate demand, so-called “hysteresis effects”, could boost innovation and growth
- By contrast, through the interaction with the financial cycle, prolonged expansionary monetary policy could lower r* over long horizons. This is because monetary policy has a major impact on debt and asset price dynamics. Prolonged monetary easing could therefore fuel debt accumulation and financial imbalances. This could push down r* because high debt burdens can weigh heavily on demand
- These findings caution against over-reliance on r* as a guide for monetary policy. The uncertainty surrounding r* suggests that it is a blurry guidepost for assessing the monetary policy stance and hence the tightness of monetary policy, in particular at the current juncture. In this context, it appears advisable to guide policy decisions based more firmly on observed inflation rather than on highly uncertain estimates of the natural rate.
The second excerpts comes from Brad DeLong's article "The Mystery of US Interest Rates" and also deals with the neutral rate of interest. Ultimately he concludes that maybe we're wrong about our estimates of the neutral rate.
- Rates today are far higher – around two percentage points – than the level anyone five years ago (before the pandemic) would have estimated the “neutral” rate to be
- An interest rate that everyone considers to be above the neutral level therefore reflects markets’ confidence that a recession – or at least a substantial slowdown – is only a matter of time. When that time comes, all will depend on whether the Fed recognizes the approaching weakness in time to cut rates and achieve a “soft landing.” This interest-rate configuration has now held for seven months.
- I suspect that the Fed is profoundly uncomfortable with interest rates substantially above what it confidently believes the neutral rate to be, especially now that inflation is very close to its 2% target. But it will not dare to shift out of reverse until it sees signs of slower job growth
- Three explanations could clarify the current situation. The conclusion that interest rates are in excess of the neutral rate could be based on an erroneous analysis. Or there could be an error in how we measure the state of the economy. Or, third, the Fed may have committed the Wile E. Coyote error. Tackling these in reverse order
- The near-consensus since the start of the pandemic has been that there are powerful fundamental factors keeping the neutral interest rate very low, and that there have been no major changes to those fundamentals. But if there is one lesson that I have learned in more than 40 years of trying to understand the business cycle, it is that there is no empirical regularity in the macroeconomy that can be trusted not to crumble beneath our feet in a remarkably short time.
The third set of excerpts comes courtesy of John Cochrane's post, "Inflation and the Value of Money" dealing with the problems of measuring inflation and the puzzle of explaining the role interest rates have played in slowing inflation.
- If we measured inflation as we did in the 1970s, the recent bout of inflation would have been even higher than the worst of the 1970s! No wonder the deplorables are ungrateful for Bidenomics
- The main difference is that the old measure counts the price and interest rate you have to pay to buy a new house as the cost of the house, while the new measure is based on what it costs to rent a house
- The new way is closer to right, if the question is to measure changes in the cost of living right now for the average person.
- The world isn’t static. The future matters. The right question might be, how much does it cost today to buy my lifetime consumption?...Buying a house locks in the right to live there forever. The cost of a lifetime of housing did go up, though today’s rents did not....If you want to know the cost of providing for a lifetime of consumption, higher asset prices and lower real interest rates mean that cost has risen. The consumer price index asks a different question. The lifetime consumption cost index would be a fun thing to calculate.
- Background: Inflation came seemingly from nowhere to most analysts. Summers and I think it was perfectly obvious — drop $5 trillion from helicopters and inflation breaks out. For Summers, that’s simple AS/AD: deficit x 1.5 > GDP gap. To me (fiscal theory) it is central that people do not expect surpluses to pay back that debt anytime soon
- The puzzle for standard analysis is that inflation eased just as the Fed started raising rates, long before rates exceeded inflation, and with no recession. Adieu Phillips curve.
- What is the effect of interest rate rises on inflation? Most estimates say inflation goes up gently for a year or two after a rate rise, before falling gently (maybe). In this context, inflation easing one month after the Fed gently started raising rates is nearly miraculous. Talk shifts to “expectations,” somehow this time a few basis points of short rate showed everyone just how tough the Fed would be.
- Conversely, maybe this observation shows a resolution of the “price puzzle” that historic estimates show inflation rising a while after interest rate rises. Maybe that was all spurious, and inflation really does turn around just as interest rates rise. Getting models to generate a delay has been devilishly hard, and to this day most modern (rational expectations, new Keynesian, forward looking) models say that inflation jumps down the minute interest rates rise. Maybe the models are (whew!) right after all.
XTOD: Being busy is a form of laziness—lazy thinking and indiscriminate action. Being busy is most often used as a guise for avoiding the few critically important but uncomfortable actions.
XTOD: Calling CRE ‘Manageable’ Is Just Wishful Thinking @business Policymakers calling the roughly $1 trillion of commercial real estate debt coming due this year “manageable” may regret it....If today’s CRE situation is anything like the savings-and-loan disaster, we’re in for a lot of trouble. It culminated in the collapse of hundreds of lenders, the insolvency of the Federal Savings and Loan Insurance Corporation — which cost taxpayers many billions of dollars
XTOD: According to the Boston Consulting Group (BCG), data centers currently represent 2.5% of U.S. electricity consumption. [At higher end of estimates], data centers could move to 7.5% of all electricity. >60% of DCs in MISO, CAISO, PJM, & Southeast.
XTOD: This thing that I am unhappy about, is it actually hard to change or is it simply hard to have the courage to change it?
https://x.com/tferriss/status/1769851793083662579?s=20
https://x.com/danjmcnamara/status/1769536480492274017?s=20
https://x.com/ShanuMathew93/status/1769738090824806422?s=20
https://x.com/JamesClear/status/1769701545719775728?s=20
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