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THE THREE


BEARS The U.S. economy, as well as global trade, appears to be decelerating into 2019, and there is virtually no inflation pressure to be observed in any of the major industrial countries.


The three bearish factors in the U.S. which we think are most important  policy-determined factors for which the resolution is decidedly uncertain,    arriving.


RATES From late 2016 through the end of 2018, the U.S. Federal Reserve (Fed) seemed to be on auto-pilot, intent on raising short-term rates at every other Federal Open Market Committee (FOMC) meeting throughout 2019 and into early 2020 before they might stop. The Fed’s rate rise  equity markets in the fourth quarter of 2018. By March 2019, the Fed was speaking in a dovish tone, was signaling no rate rises in 2019, and announced an early halt to its program of reversing quantitative easing (QE) and shrinking its balance sheet.


Our analysis is that the Fed made two errors in its policy planning. First, the Fed chose a reasonable yet inappropriate target for achieving interest rate neutrality. Second, the Fed was focused too much on raising short-term interest rates, so it would have room to cut them if there was a downturn in the future.


 neutral interest rate policy that is neither restrictive or stimulative has been a matter of debate among economists for over a century. The yield curve approach was put forward by some notable economists in the 1920s, including Irving Fisher in the U.S. and Knut Wicksell from Sweden. The concept was based on the idea that investors should receive a premium for long-term lending relative to short-term lending. Thus, a neutral interest rate environment was one in which the yield curve sloped gently upwards, with short-term rates being lower than long-term bond yields. A steep, positively sloped yield curve with short-term rate relatively low compared to bond  yield curve with short-term rates more or less equal to long-term yields would be restrictive. And, if the yield curve was inverted, with long-term yields below short- term rates, that would be exceptionally restrictive. While this interpretation of what the yield curve signals for the economy has a timing problem, it has been extremely directionally accurate. That is, once the  months, equity volatility increases, and economic growth decelerates, sometimes into a recession.


The Fed, under former Chair Janet Yellen and now under Jay Powell, took the view that neutrality of interest rate policy was most closely related to  (excluding food and energy) and short-term rates or the Fed’s target range for the federal funds rate.  was to create a small premium in the federal funds  important to note that the Fed also was expecting   for a little above a 3% federal funds rate as achieving interest rate policy neutrality.


26 | ADMISI - The Ghost In The Machine | March/April 2019


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