The Yellen Fed risks Faustian pact with inflation
AMBROSE EVANS-PRITCHARD
Telegraph.co.uk
17 MARCH 2016
Interest rates in the United States have fallen to minus 2pc in real terms and are dropping into deeper negative territory with each passing month. This is a remarkable state of affairs.
It is clear that the US Federal Reserve is now trapped. The FOMC dares not tighten despite core inflation reaching 2.3pc because it is so worried about tantrums in financial markets and about that other Sword of Damocles – some $11 trillion of offshore debt denominated in dollars, up from $2 trillion in 2000.
The Fed has been forced by circumstances to act as the world’s central bank, nursing a fragile and treacherous financial system struggling with unprecedented leverage.
Average debt ratios are 36 percentage points of GDP higher than they were at the top of the pre-Lehman bubble in 2008, and this time emerging markets have been drawn into the quagmire as well by the spill-over effects of quantitative easing. Like it or not, the Fed is stuck with the task of cleaning up a global mess that is arguably of its own making.
You can certainly make a case that the Fed was right to hold rates steady this week and – crucially – to signal just two more rises over the rest of the year. The risks are not symmetric. It would be fatal if the US economy failed to achieve “escape velocity” and then slid back into deflation, leaving no margin of safety before the next downturn.
Yet however well-intentioned, the Fed’s policy is fast becoming untenable. The Cleveland Fed’s median index of underlying inflation is already up to 2.8pc. Healthcare costs, car insurance, rents, restaurant bills, hotels, and women’s clothing are all soaring.
Marc Ostwald from ADM said the Fed’s governors have effectively told the world that “they will remain forcefully ‘behind the curve’, and ignore their own forecasts of a very tight labour market”.
They are searching for excuses not to tighten, either by discovering yet more “slack” in the shadows of the penumbras of the remotest corners of the jobs market, or by dismissing the inflation data as spikey, transient, and unreliable.
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