McGeever: Central banks in the US have a rate problem.
The Federal Reserve and other central bankers are faced with an acute problem due to the acceleration of inflation in the U.S. The Federal Reserve may want to be patient, but the continuing rout of bonds is sending a message that rates should be raised now.
Last week, unexpectedly strong U.S. data on inflation pushed the real inflation-adjusted Fed funds rate below zero for the first time in three year. The Fed must act to prevent inflation from pushing real rates further into negative territory if it does not. A closely watched Philadelphia Fed survey on Friday of professional forecasters forecast headline CPI inflation of 6% this quarter.
Negative real interest rates are very stimulative. Keeping inflation-adjusted rates below zero during one of the biggest energy shocks in history seems counterintuitive.
The fact that the real value of the dollar has dropped below zero reflects both the sudden nature of the crisis and the rapid rise in inflation, but it still puts policymakers in a difficult position.
Most central bankers have not yet raised rates, despite the fact that the Reserve Bank of Australia (RBA) and Norges Bank (Norges Bank) had already done so. They may wait weeks or months to see the impact on employment and growth of the energy crunch before considering a rate hike.
This plan didn't work out very well for 2022. With consumer prices increasing, inflation expectations rising, and bond markets crashing, the time is running out for them.
UK SHOE NEXT DROP?
The Fed is not the only one.
Only the Bank of England Base Rate is currently positive in real terms. This will change if or when UK inflation reaches 3.75 percent. Currently, it is 3.3%.
The European Central Bank has the lowest inflation-adjusted rate of policy since 2023, at -1 %.
Since 2021, Japan's real policy rate is?negative as the Bank of Japan tries to fight the deflation dragon. The Iran War has prevented rates from turning positive. Japan imports 90% its energy. As a result, inflation is likely to move north.
The CPI report for Japan will be released May 21, one day after the UK CPI data.
Bond yields have not risen solely as a result of supply shocks related to Iran. The artificial intelligence boom is also fueling inflation, as it has released a global demand wave for chips and other technology.
According to some estimates, U.S. hyperscalers could collectively spend over $800 billion on AI-related capital expenditures this year. By 2031, the cumulative AI infrastructure investment is expected to reach $7.6 trillion.
The market capitalization of major chip suppliers reflects these huge expenditures. Nvidia, the U.S. AI darling, only needs to see its shares rise by 9% more to reach $6 trillion in market capitalization. Meanwhile, South Korean chipmaker SK Hynix whose stock price was $100 billion a few years ago is on track to achieve a $1 trillion valuation.
NEGATIVE FEEDBACKWARD LOOP
AI mania has pushed the Nasdaq 500 and S&P to new highs despite a strong dollar and a punchy treasury yield. Goldman Sachs says that financial conditions in the U.S. have been the most relaxed for four years.
In fact, in many parts of the developed world, an unstoppable cycle has been created. Falling interest rates boost stock prices which in turn loosens financial conditions and encourages more spending and investment.
Add to this the fact that inflation has been rising in the U.S. for over five years and it becomes more difficult to understand why the Fed is reluctant to raise interest rates. The current bond market turmoil suggests that investors are losing patience.
Phil Suttle, an economist, says: "I'm not sure we're quite at the dangerous Fed denial point yet but we're getting there."
Kevin Warsh is about to enter a new era as the Fed chair, and this backdrop will be a test for him. Not least because he previously expressed a preference for?lower interest rates. He was appointed by a president who wants to lower interest rates.
It will be difficult to convince people that real rates, the "true price" of money, are below zero.
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(source: Reuters)
