Fed Raises Rates Too Soon!

Popular Economics Weekly

The Federal Reserve FOMC meeting ended with the predicted 0.25 percent rate hike; but it’s happening at the wrong time.  This is the rate that controls credit card interest and the Prime Lending Rate banks use on short term loans, which will now become more expensive, slowing consumer spending, and hence economic growth, for starters.

That is what the Fed Governors seem to want, even though growth is still weak; too weak to warrant continued tightening.

Few follow the trajectory of the so-called Treasury yield curve which graphs the difference between short and long-term interest rates. The curve is flattening at present—not a good sign for future growth, either. Instead, it’s historically a sign of slowing growth. 

Graph: FRED

DoubleLine Capital CEO Jeff Gundlach said this morning on CNBC the flattening yield curve is becoming worrisome, even with all signs pointing to no recession on the horizon. It will hurt junk bonds, for starters, especially, as well as investors that are highly leveraged.

Why? The Fed is tightening at the same time as the Repubs’ proposed tax bill will add at least $1.5 trillion to liquidity with the increased budget shortfall. So Republicans are fighting Fed policy, and we know where that will end. Federal Reserve policy always wins!

Short term rates are the cost of money to banks, and longer-term interest rates are what they earn on loans. When the difference narrows, bank profits plunge and they lend less to businesses, which shrinks available credit, even with the additional liquidity.

But CEOs are saying they will return most of the increased profits from any tax cut back to their investors, rather than boosting employees’ incomes. And wages and salaries are two-thirds of product costs, which means no meaningful inflation happens if incomes don’t rise.

Where will the money come from to do some of the $2 trillion in deferred infrastructure maintenance, according to the ASCE, not to speak of modernizing our power grids, airports, and transportation network?  The huge debt increase will make it more expensive to build out the infrastructute that's needed.

Some good news is that factory orders are soaring. Econoday reports factory orders have had a respectable year, moving to roughly $480 billion per month and near a 3-year high. “Year-on-year, orders are up $17 billion or 3.7 percent. Vehicle orders have been showing recent strength and reflect the rush of hurricane-replacement sales, yet the big contributor has been capital goods where annual gains are approaching 10 percent. And investing in capital goods are needed to expand production and even labor productivity."

 

So we have the Fed wanting to slow down what they see as accelerating inflation, which is probably because they anticipate the increased federal budget deficit (and decreased tax revenues) from Republicans single-minded obsession with tax cuts that may or may not help economic growth.

But if corporate CEOs keep their profits in-house, and won’t spend a substantial amount on increasing wages and salaries, there is no inflation increase, and so no acceleration in GDP, ever.

Harlan Green © 2017

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