Credit Bubble Bulletin2020-05-20T17:01:05-06:00

Presented by Doug Noland

Daily Commentary

Tuesday, August 9, 2022

[Yahoo/Bloomberg] Stocks Slip Amid Focus on Earnings, Inflation: Markets Wrap

[Yahoo/Bloomberg] Oil Rallies After Russian Flows Halted Via Key Pipe to Europe

[Reuters] U.S. productivity drops in second quarter; annual decline largest ever

[Reuters] U.S. small business sentiment edges up in July, NFIB says

[Reuters] Shrinking U.S. cattle herd signals more pain from high beef prices

[MSN/WP] China shifts the military status quo on Taiwan after Pelosi visit

[Reuters] Taiwanese foreign minister says China drills part of a game-plan for invasion

[Reuters] Taiwan minister: China seeks excuses for military drills, and used Pelosi’s visit

[Yahoo/Bloomberg] China Graft Probes Stem From Anger Over Failed Chip Plans

[Yahoo/Bloomberg] China Orders Surprise Audit of $3 Trillion Trust Industry

[Reuters] Moscow steps up assault in eastern Ukraine as Kyiv calls for ‘ban’ on Russians

[Yahoo/Bloomberg] Russian Oil Flows Halted Through Pipeline to Central Europe

[Reuters] Tourist boats marooned, farm land parched as drought lowers Europe’s rivers

[Reuters] Mexico’s July inflation at highest level since 2000

[Bloomberg] China Property Woes Spark Longest Mortgage Debt Halt Since 2015

[Bloomberg] Taiwan Says China Using War Drills to Plan a Future Invasion

[WSJ] Rapid Wage Growth Keeps Pressure on U.S. Inflation

[WSJ] Market Rout Sends State and City Pension Funds to Worst Year Since 2009

[WSJ] Battle for Southern Ukraine Intensifies as Zelensky Calls for Total Victory

[FT] Taipei accuses Beijing of trying to take control of Taiwan Strait

Weekly Commentary

August 5, 2022: Indefensible Neutral Rate Doctrine

Bloomberg’s David Westin (Wall Street Week, July 29, 2022): “What do you economists do when you put together these neutral rates?”

Larry Summers: “I think Jay Powell said things that, to be blunt, were analytically indefensible. He claimed twice in his press conference that the Fed was now at the neutral interest rate – calling it 2.5%. It’s elementary that the level of the neutral interest rate depends upon the inflation rate. We’ve got on the most quoted measure a 9.1% inflation measure – if you extrapolate it off core it’s four or five percent inflation. There is no conceivable way that a 2.5% interest rate in an economy inflating like this is anywhere near neutral. And if you think it is neutral, you are misjudging the posture of policy in a fundamental way. So, I was very sorry to hear him say that and, frankly, surprised. He said back in 2018 that the Fed was approaching the neutral interest rate at a time when the inflation rate was 1.9%. How he could be saying the same thing today, when the inflation rate is where it is, is inexplicable to me, and it’s the same kind of, to be blunt, wishful thinking that got us into the problems we have now with the use of the term ‘transitory.’ So, I hope the rigor of the economic analysis at the Federal Reserve is going to step up.”

Powell provides an easy target these days. But when it comes to the “neutral rate” discussion, the entire economic community is implicated. The concept has never been on sound footing. As far as I’m concerned, the concept of calibrating monetary policy based upon some nebulous “neutral rate” is Indefensible. Analytical quicksand.

But let’s start with Powell’s assertion. While I believe interest rates will need to go significantly higher to crush powerful inflationary forces and inflation psychology (all bets are off in the event of a market accident), at least within the context of the Fed’s current framework, his claim of near neutrality was defensible.

The Fed’s current operating doctrine is to regulate system financial conditions chiefly through the financial markets (in stark contrast to the traditional model of regulating system Credit through adjusting bank lending conditions). In the contemporary Fed view, the primary monetary policy transmission mechanism works through market expectations for the path of short-term policy rates. Higher market yields, lower asset prices, and general risk aversion are expected to tighten financial conditions, reducing both economic demand and upward pricing pressures.

Monetary policy, of course, works with a lag. Powell referred to “financial conditions” 17 times during his May 4th press conference. The Fed’s view has been that it will not be necessary to raise rates aggressively to the point where key inflation measures are back to the 2% target level. Federal Reserve officials will instead closely monitor for a significant tightening of financial conditions that would precede waning growth and abating pricing pressures. A few aggressive rate hikes and tough inflation talk will quickly spur tighter market conditions, ensuring a downward inflation trajectory over the coming months and years. Or so they hope. (more…)

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