E Fed Signals Will Break The Economy. Wait Til Trump Finds Out

Tim Duy, an economist at University of Oregon and contributor to Bloomberg View has an ominous prediction. The Fed won't change, just like a leopard won't change its spots, and will likely establish the same policies that it has in the past to break the economy. Duy said:

...What I find most interesting is the adherence to these models even though, as Evans says, they will sustain the economy in the zone where the zero lower bound is likely to be an issue once again. One would think the Fed would continue to adjust policy accordingly in a dovish direction but increasingly is looks like many policymakers intend to 1.) fall back on old models and 2.) accept the likelihood of a return to the zero bound and be ready to use unconventional policy as needed. That strikes me as hawkish – the Fed said policy normalization is underway, and they mean it.

Bottom Line: Expect the rate hikes to keep coming. No reason to pause this year. In some sense, expecting a pause even after policy rates hit neutral is more hope than anything else.

Normalization, of course, will run up against the long bond conundrum. The likelihood of a return to the zero lower bound is great, as Professor Duy says, and for me, a hurtful liquidation and then quantitative easing and Fed balance sheet expansion will follow. It looks like procyclical Fed behavior is here to stay.

This certainly is not what Donald Trump wants to hear. He wants big growth, and the Fed is not going to let it happen. This chart may be the reason why. Notice that labor participation, overall, is the percentages shown on the left and shown with the blue line. That is stable, boringly stable, and historically low compared to over 66 percent before the Great Recession. But the red line and the percentages of young men and women age 24 to 54 is exploding, with a recent slight pullback. We can see participation for that group at over 82 percent!

 

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Disclosure: I have no financial interest in any companies or industries mentioned. I am not an investment counselor nor am I an attorney so my views are not to be considered investment ...

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Norman Mogil 5 days ago Contributor's comment

Gary, when you add the rising Fed deficit each year to rising Fed funds rate, the mixture could be toxic in a few years. Right now, the world is still buying USTs---mainly because of the problems in the EMs---but that could change for the worse.

Gary Anderson 5 days ago Author's comment

I think the Fed will make it necessary to buy bonds, as a sort of protection. So, I wonder if the deficit is just a means of providing more needed bonds to Wall Street. I think the Fed wants to break the economy rather than tolerate just a thimble full of inflation. Guarding the collateral is the most important for them at this point. I could be wrong, but a hawkish Fed is gaining momentum. That hawkishness will raise short rates, but long rates seem stuck in a permanent range. If they go a little above the range, the Fed will slow even more.