The Fed Proposes, the Bond Market Disposes

Here’s what almost everyone is wrong about. There’s a debate about whether the Fed should gradually “normalize” interest rates over the next few years. And indeed the Fed has laid out a plan to raise rates into the 3% to 4% range over the next three years.

Unfortunately, the Fed doesn’t get to decide the path of interest rates. It looks like they do, but that’s a cognitive illusion. The band market determines the path of interest rates, reflecting factors such as global credit markets, as well as NGDP growth and the level of NGDP in the US. If the Fed tried to independently determine the path of interest rates it would lead to hyperinflation or hyperdeflation.

Today was another lesson in humility for the Fed. Bond yields have been plunging, which is the bond market’s way of saying, “Oh no you don’t, there’s going to be no normalization of interest rates over the next few years.”

Resistance is futile. The more the Fed resists and tries to force rates sharply higher, the more the economy slows, and the more downward pressure on rates in the bond market. In the end, the bond market always wins.

The Fed should stop focusing on trying to hit its interest rate targets, and start focusing on hitting its inflation target. It’s not the Fed’s job to set interest rates. Even better, we should make their job much simpler by switching to NGDPLT.

The most noteworthy aspect of today’s jobs report is that the wage acceleration that everyone’s expecting again failed to show up.

Some die hard opponents of “The Great Stagnation” had held out hope that a fall in U-6 unemployment (the broadest measure) would propel future growth. Now even that option is mostly gone, as it plunged to 10.0% in September, the same level as in February 1996.) It will go a bit lower, but it no longer represents a large cache of workers waiting in the wings to propel us forward. Get ready for the new normal—3.0% NGDP growth—it’s coming soon.

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