There’s been quite a bit of discussion regarding the driver behind the rise in long-term interest rates that appeared to coincide with the release of the FOMC statement and the Bernanke press conference on June 19.
Scott Sumner thinks it’s a bullish sign. Lars Christensen thinks it might have something to do with monetary tightening in China. David Glasner and Marcus Nunes think the Fed is the cause. I don’t have an opinion, except that it is likely the collision of different events that may never be conclusively disentangled.
I am not sure that it matters very much. In my professional life, I used to have a problem with getting tangled up in the unknowns when it came time to decide on a course of action. I was lucky to have a great manager at the time that passed on some very important advice: When you cannot delay a decision, you have to go with what you know; and try as hard as possible to err on the side of caution. He said, “That’s all you can do.”
So what do we know?
- NGDP is ~15% below the long-run trend.
- GDP and wages are stagnant
- The labor force is the smallest it’s been since the early 1980s
- Markets respond with leads
- There are record numbers of adults on disability and other social benefit programs
- Core PCE is falling (headline is declining faster – where the supply shock, if one is occurring, would show up)
- The Fed just tightened policy and the largest portion of the move in rates coincided with the announcement
Given what we know, it is quite convincing that the Fed committed a policy error in the larger picture. It is not erring on the side of caution, at least not as far as the health of the economy and society in general is concerned.
The faster movement in long term rates might simply be, if taking Friedman’s view of interest rates to heart, a refection that because the Fed didn’t step on the brake completely and provided a little more certainty, policy will be a bit less tight once the “taper” is complete. But as we can see, the market-forecasted finish state is but a drop in the bucket compared to the task.
By the way, I agree that there could be a positive supply shock talking place, though I don’t necessarily understand where. I haven’t noticed a large swing in gas and energy prices, although food seems to have finally stabilized over the last year. I think it’s a red herring, however, as it would show up mostly in headline measures, while core is showing very little decline; and our advice to the Fed, in the very least, has been to ignore headline. And in that regard, it still has quite a bit of catch up to do if it had a symmetrical, long-run target – which has been painfully obvious that it does not. We shouldn’t let the Fed off the hook for not following the policy it stubbornly hangs onto. If it were devoted to that policy, as bad as it is, it would be a vast improvement over what we have now.