The Federal Reserve should stick
with a “wait-and-see monetary response” absent more evidence of sustainable
inflation gripping the U.S. economy, Chicago Fed President Charles
Evans said Tuesday. That seems to be
Fed Chairwoman Yellen’s
response to current world events, as well.
But what is ‘sustainable inflation’,
really? It’s a code word for sustainable
growth, as past history tells us we really need an inflation rate that is more
than the Fed’s 2 percent target to achieve GDP growth that is sustainable.
Evans — considered to be one of the
policy panel’s doves but perhaps no longer an outlier with that view — said
he’s willing to allow the U.S. economy to tip above the Fed’s roughly 2 percent
inflation target to gain assurance that flares in inflation signals aren’t
transitory, even masking economic trouble-spots that might benefit from a
go-slow Fed. Factors dragging on growth potential right now include: weaker
corporate spending, low commodities prices, China’s economic slowdown and
market volatility, he told the City Club of Chicago.
There’s also the U.S. Dollar’s
strength, which is harming our exports (read manufacturing sector) because it
is in such demand as the world’s reserve currency and considered a safe haven
for foreign investors that are leery of investing otherwise amidst the current
geopolitical uncertainty.
And if the Fed does boost interest
rates further than last December’s one quarter percent hike, it will boost the
dollar’s value higher, thus making U.S. exports even less competitive in the
current hyper-competitive world trade environment. Such a trade environment with
low trade barriers means almost anyone anywhere can produce what is needed,
resulting in a world awash in goods and services. The current oil glut is just one example that
is depressing commodity prices.
And, as I said last week, though
several of the Fed’s Open Market Committee are still pushing for higher
interest rates, there is little sign of inflation at the wholesale or retail
level, which means wages are not rising fast enough (that approx. 2/3rds of
product costs) to boost consumer demand, and hence economic growth.
The good news is that manufacturing
seems to be recovering, even with the strong dollar. The Philly Fed and Empire State manufacturing
reports are the first positive signals of factory activity during the month. A look at February’s industrial indicators also
show definitive evidence of recovery, says Econoday. The manufacturing component
of the industrial production report posted a surprising 0.2 percent gain which
came on top of January's stunning gain of 0.5 percent.
Why the manufacturing pickup after 6 months of
decline? The dollar is down a surprising
3.8 percent on the dollar index, making our exports less expensive to foreign
customers. The above Econoday graph tracks the index value of the manufacturing
component against monthly dollar totals for exports.
Exports
have been sinking sharply for more than a year in what, by contrast,
underscores the formidable strength of domestic demand. Yet the drop in the
dollar has been accelerating. It is
probably because the Fed’s Open Market Committee has been backing off its
promise to raise short term rates as much as 4 times this year.
So we should listen to Fed Governor Evans. Higher inflation is necessary at his time and
should be allowed, before the Fed raises rates further. Any sign that inflation could be a danger to
growth would be almost instantly reflected by higher yields in the bond
markets. And today’s US 10-year Treasury
Bond is yielding an absurdly low 1.9 percent.
Harlan Green © 2016
Follow Harlan
Green on Twitter: https://twitter.com/HarlanGreen
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