Monetary straitjackets are not easy to take off

Faster inflation is expected given the trends in breakeven inflation rates. Bond yields have risen as rate expectations have risen in a sort of arms race between expected inflation and expected rate rises to calm the expected inflation.

This is only partly driven by expectations of economic trends, a related part is the expected liquidity impact of higher supply of bonds to fund the fiscal policies themselves. This powerful cocktail drives down bond prices independent of inflation expectations.

Our market-influenced NGDP Forecast is not yet showing faster nominal growth. (Please take out a free trial or subscribe to see our proprietary chart in full.)

The implication is that there is going to be lower Real GDP growth ahead.

The current consensus is that Real GDP growth will hang around 2% or perhaps a little above – despite many commentators suggesting that the equity rally implies that Real GDP growth will be strong. The Survey of Professional Forecasters from the Philadelphia Fed, for example, puts real growth at 2.2% at an annual rate for every quarter of 2017.

We are Market Monetarists and what the markets tell us is very important.

The fact that equities have gone up a bit is interesting information but is not conclusive about the trend for either Nominal or Real GDP growth. Higher inflation is just as good for nominal equity prices as higher RGDP.

The split between RGDP and inflation is actually telling us that there will be lower RGDP ahead. Is a higher share of NGDP growth from inflation a good thing? Not if it means suppressing RGDP growth.

Sometimes with inflation, companies will appear busier and that can be helpful to share prices in the near term but real growth will be elusive. In fact, it could suppress margins and therefore profits.

Too low projected inflation targets, that are really ceilings, are like monetary straitjackets. They will keep nominal growth low and thus suppress real growth. The suppressors cannot be taken off without the central bank altering its mode of thinking or targets.

Central banks very rarely change their thinking or targets, for good reason. However, if the mode of thinking or targets are the cause of persistent low growth (aka “Long Depression”) then they need to change, through either internal debate or external direction.

The Fed seems blissfully happy to ignore the one thing under their direct control that is indicating tighter and tighter money: Base Money.

The monetary base has been dropping due to the additional policy tool of Reverse Repos. They are reducing the Fed’s holdings of Treasuries by stealth and sucking out liquidity from the economy. The declining trend in Base Money is the visible face of the straitjacket and it is gripping the economy hard, whatever “confidence”, equities or car sales are saying.

The “external direction” change is Trump’s opportunity, of course. Nevertheless, will he grasp it? Signs from many inside his camp are not encouraging that what needs doing is understood.


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