McGeever: Central banks in the US have a rate problem.
The Federal Reserve and other central bankers are facing a serious problem due to the rapid acceleration of inflation in the U.S. The policymakers may want to remain patient but the current rout of bonds is sending out a clear signal: raise rates immediately.
Last week, unexpectedly strong U.S. data on inflation pushed the real fed funds rate below zero - the first time in three years. The Fed must act to prevent inflation from pushing'real' rates even lower. The Philadelphia Fed's survey of professional forecasters, conducted on Friday, predicted headline CPI inflation of an astounding 6% for this quarter.
Negative real interest rates are very stimulative. Keeping inflation-adjusted rates below zero in the face of one of the biggest energy shocks ever experienced by mankind 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 acted, despite the fact that the Reserve Bank of Australia (RBA) and Norges Bank (Norges Bank) have already pushed the "trigger" on rate increases. The central bankers may wait weeks or months to see how the energy crisis affects employment and growth before they consider rate increases. They hope that the bond markets will do the heavy lifting, and that inflation spikes are temporary.
This plan didn't work out very well for 2022. Time is running out for them, as consumer prices are rising, inflation expectations are increasing, and the bond markets are crashing.
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. It is currently at 3.3%.
The European Central Bank’s inflation-adjusted rate of policy is the lowest since 2023, at -?1%.
Since 2021, Japan's real policy rate has been negative as the Bank of Japan tries to fight the deflation dragon. The Iran War has prevented the 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 unleashed an unprecedented global demand for chips and other technology.
According to some estimates, U.S. hyperscalers could collectively spend over $800 billion on AI-related capital expenditure this year.
The market capitalization of major chip suppliers reflects these huge expenditures. Nvidia, the U.S. AI darling, only needs to see its shares rise 9% more to reach $6 trillion in market capitalization. Meanwhile, South Korean chipmaker SK Hynix whose stock price was just $100 billion a year earlier is on track to become a company worth $1 trillion.
NEGATIVE FEEDBACK LOOPS
AI has pushed the Nasdaq 500 and S&P to new highs in 2018 despite the soaring Treasury yields. Goldman Sachs says that financial conditions in the U.S. have been the most relaxed in four years.
In many developed countries, an unstoppable cycle has been created. Falling interest rates boost stock prices which in turn loosens financial conditions and fuels more spending.
Add to this the fact that inflation has been rising in the U.S. for the past five years and it becomes more difficult to understand the Fed's hesitation 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 are on our way there."
The incoming Fed chair Kevin?Warsh is in for a tough time, not least of all because he previously expressed a preference for "lower interest rates". He was appointed by a president who wants rates to be lower.
It will be difficult to convince people that real rates, the "true price" of money, are below zero.
You like this column? Open Interest (ROI) is your new essential source of global financial commentary. Follow ROI on LinkedIn and X.
Listen to the Morning Bid podcast daily on Apple, Spotify or the app. Subscribe to the Morning Bid podcast and hear journalists discussing the latest news in finance and markets seven days a weeks.
(source: Reuters)
