If Jerome Powell made anything clear during his May 1 press conference (and I’m not at all sure he did), it was that the Fed lacks sufficient confidence in the outlook.
The Committee isn’t sure about much, and the inflation data covering the first three months of 2024 didn’t do them any favors. In fact, Powell admitted, the incoming data served to detract from whatever confidence officials had regarding the likely path of inflation going forward.
When reality steadfastly refuses to conform to expectations, it’s often useful to revisit your assumptions. Because they might be wrong. Outside-the-box thinking can be helpful.
The Fed and its many critics have at least one thing in common: They’re unwilling to seriously entertain the idea that high rates are actually stimulative in the US context or, more precisely, that the stimulative effects of high rates in the current conjuncture are outstripping the restrictive effects, with the net result of stronger demand.
The precision’s important, I think. We don’t need to burn the textbooks. (We probably should, but that’s a separate discussion.) And we don’t have to be “radicals” or fully embrace heretical heterodoxy. It’s enough to say that in the context of i) very low rates on the nation’s mortgage stock, ii) the very low share of variable-rate debt on household balance sheets, iii) historically elevated aggregate corporate cash balances and iv) a weighted average corporate coupon that’s half of what it was 30 years ago, high rates (and the inverted curve) are delivering a demand boost large enough to offset the restriction implied by current policy settings.
When you spell it out that way, it doesn’t seem like such a “radical theory,” as Bloomberg (and others) have described it.
In his latest, published (amusingly) four minutes into Powell’s mid-week press conference, SocGen’s Andrew Lapthorne asked if higher rates boosting asset prices. Lapthorne, regular readers will recall, has been all over this for the better part of 18 months.
The figures below use straightforward math to illustrate the magnitude of the interest income windfall.
Note from the chart on the right that corporate cash is rising again, or at least drifting up after falling sharply from the pandemic peak.
If you assume US money funds and cash on corporate balance sheets earns the funds rate, you come away with “a $420 billion boost in interest payments,” Lapthorne wrote, before providing some context: Dividend payments on the MSCI World are around $1.2 trillion.
“Many individuals and corporates are benefiting from a massive cash flow boost from much higher interest payments,” Lapthorne said, matter-of-factly. “Perversely, this is supporting profits and maybe asset prices.”
Of course, higher asset prices tend to bolster household spending through the “wealth effect” channel, and they (buoyant asset prices) also serve to ease financial conditions.
Don’t expect this “theory” to get any serious attention from the “serious” people. They have better things to ponder, after all. Like why inflation’s stubborn despite a five-handle funds rate.
Related: The ‘Radical’ Economic Theory Taking Markets By Storm
Somehow, we fool ourselves into pretending we know what the past meant.
and now that QT is on the way out, liquidity won’t be as big of an issue. Combine this with massive interest income and you have an economy that won’t quit. To the moon! lol
How is money supply seemingly growing when it is supposed to be getting destroyed?
Continuing post-Covid velocity blues?
This has me thinking about the reverse of a dynamic that was more on-topic years ago. The “transmission channel” of QE wasn’t what Bernanke had hoped, as discussed here plenty of times. Running in reverse, it’s still not transmitting to Main Street to offset inflation where it’s needed.
Time to replace the Fed’s hammer with an AI based multi tool 😉
Assume this scenario for the US over the next six months: inflation sticky, jobs strong, economic growth unchanged, Fed frozen, geopolitical unchanged. What are the N6M investment implications?
I have also been shouting this from my very small reseach rooftop. The disconnect is clear. Only 20% (or fewer) voters are cash balance positive in a significant way. AND 50% of all individuals are short net assets and are borrowing month to month at 20% (and up) to stay afloat. Those struggling are voters and every one of them gets one (1) vote – (it is not asset weighted like Powell’s numbers) and they think Biden is doing a terrible job. TRUMP WINS in a walk (if he can shut up) because of inflation compounded by high rates (for renters and poor)
There are definitely two distinct economies right now. Half of the small businesses are floundering (mine included). Jamie Dimon beamed today that the US economy is booming, because Wall St hates to learn hard lessons (Occupy, anyone?). Biden would be best served raising capital gains to the sky and personally handing out large envelopes stuffed with cash along Main St.
But I digress…..
So if tech is booming and high interest returns, booming hard assets, etc are fueling shangri-la for the upper crust, what is a Central Bank to do? Seriously, what is the answer?? What could Powell do if they were to properly assess (admit) to this problem?