Debt Ceiling, Inflation Dilemma

With the debt ceiling solved (for 3 months anyway), a potential market calamity has been avoided (for at least 3 months, Happy Holidays).   This week’s speech by Fed governor Lael Brainard indicated a reluctance to raise rates further until they are confident they can get past the “persistent failure” to reach their stated goal of 2.0% inflation.  Last week’s PCE came in at 1.4%, down from 1.6% earlier in the year.  It’s another sign that central banks are now trying to comprehend the “new normal” where the old model of the inverse relationship between interest rates and inflation is “broken” as years of accommodative policy has failed to increase prices.  It’s interesting to note that this may indicate that its easier for central banks to quell inflation (by raising rates as the Fed did effectively periodically from the mid 1980’s until 2007) than increase inflation (by lowering rates).  Two recent reports, one by Morgan Stanley and another by the Bank for International Settlements, shed some light on other factors including: (1) Aging populace in first world countries increasing savings; (2) Decline of labor unions (decreasing workers’ ability to demand pay raises), (3) Globalization (same effect as #2 and creating a “race to the bottom” for manufacturing costs); (3) Disruptive technologies (Uber, Airbnb, etc.) are eliminating middle men, increasing competition and forcing traditional companies to compete on price;  (4) Amazon and other huge firms are concentrating on market share rather than profits; (5) Lower inflation expectations, i.e. a long period of low inflation leads to market participants (consumers, manufacturers) expecting tomorrow to be like today and yesterday.  The Dallas Fed joined the “thinkfest” by announcing it is studying globalization’s affect on inflation.  The 10 year T broke through a key technical level of 2.13% this week, dropping to 2.06% and is now at 2.10%.  The flight to quality is still on as investors are watching the continued saber rattling with North Korea and the U.S. and the unquantified economic fallout from Hurricane Harvey and the approaching Hurricane Irma….stay tuned

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