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‘Crazy’ Tight? Actually, Fed Still Looks Loose by These Measures

‘Crazy’ Tight? Actually, Fed Still Looks Loose by These Measures

  • Real rates, financial conditions contrast with Trump’s claims
  • No evidence that rates are broadly biting into expansion yet
John Authers Explains the Fed's Role in 'Long Overdue Correction'

President Donald Trump is criticizing his hand-picked Federal Reserve chief at a time when interest rates show few signs of hindering the U.S. economic expansion.

“I don’t think there is any doubt that interest rates” at current levels are adding stimulus to the economy, said Mark Spindel, co-author of a 2017 book on the central bank. “Trump wants every form of stimulus possible -- it’s pedal-to-the-metal on fiscal policy, dollar policy and monetary policy.”

Trump lashed out at the Fed for a second day on Thursday, blaming it for the worst U.S. stock-market selloff since February, though he said he won’t fire Chairman Jerome Powell. “They’re so tight. I think the Fed has gone crazy,” the president said Wednesday.

All the Ways Trump Can (And Can’t) Influence Powell’s Fed Policy

U.S. central bankers have raised the benchmark lending rate three times this year, and investors see more than 70 percent probability of another hike in December. Officials are gradually raising rates to keep inflation around their 2 percent target, while unemployment drifts below levels deemed to be consistent with stable prices. That strength is in part fueled by tax cuts and federal spending increases signed by Trump.

Yet there is little evidence that rates are too tight given current economic conditions, as shown by the following three charts.

Financial Conditions Are Easy

Throughout the Fed’s tightening cycle, which began at the end of 2015, financial conditions have been relatively easy. The latest stock-market decline has tightened some measures, but they’re still within a long-term range. Financial conditions indexes not only measure current rates, but incorporate long-term borrowing costs, the dollar and credit spreads. In other words, the steady rise in the Fed’s policy rate, and estimates for future hikes, haven’t translated into harsh financing conditions for the overall economy yet.

Fed rate hikes aren't aggressively raising financial costs

Real Interest Rates Are Low

The cost of money, after inflation, matters. For example, a grocery store that raises prices by 2.5 percent a year, and borrows in short-term markets at 2 percent to finance that inventory, is pocketing a half-percentage point on rates alone, not even including the mark-up between wholesale and retail prices.

Real Fed Funds rates barely above zero for the first time in a decade

Put another way, very low real interest rates favor borrowers over savers. The average yield on the 100 largest taxable U.S. money-market mutual funds averaged 1.95 percent this week, according to Crane Data. Deflating that figure by the 2.3 percent rise in consumer prices for the 12 months through September shows investors earning minus 0.35 percent on their savings after inflation. So it’s a great time to be a borrower, and a lousy time to be a saver because Fed policy is tightening at a slow and gradual rate.

Rates Not Hurting Business

Job gains averaged 208,000 per month for the first nine months of 2018. The National Federation of Independent Business’s small-business optimism index posted its third-highest reading last month in its 45-year history. The share of owners reporting capital outlays was 60 percent, near the high of 66 percent during this expansion, with 41 percent of those reporting spending on new equipment, the group said.

Gains in nonfarm payrolls on upward trajectory

When expenditures on capital and labor are strong, companies are betting that robust demand will allow them to profitably grow their businesses. The data suggest there’s little sense that interest rates are biting down on their business outlook.

Further interest-rate increases are “not unreasonable” given the strength of the expansion, said James Knightley, chief international economist at ING Groep NV in London. “It is going to take a lot to knock the U.S. economy right now.”

— With assistance by Alexandre Tanzi