Will The Fed Be Trapped Like The BOJ?

The Fed wants to avoid, at all costs, entering the next recession with limited ammunition. Japan has been unable to sustainably lift rates since the turn of the century. Every time the BOJ has attempted to tighten monetary policy, the economy has endured recession. The highest it managed to lift rates was to 0.5% leading up to the Great Recession. The zero lower bound has served as a magnet, severely handicapping Japanese conventional monetary policy.

This is clearly a predicament the Fed wants to avoid, but the similarities with Japan are ee¬rie. The chart highlights that the Fed is closely following in the BOJ’s footsteps. Similarly, the lower bound of the 70% confidence interval of the Fed’s June median fed funds rate pro¬jection, as highlighted by Janet Yellen in her Jackson Hole speech, is flirting with the zero line. While we are not arguing that the U.S. is Japan, the odds are that the Fed will not have raised the Fed funds rate by enough in order to regain policy latitude for the next recession.

Our sense is that the Fed will likely wait until the economic dust settles before raising rates, as the risk/reward tradeoff favors a temporary 3-month deferral of the next rate hike.

For additional details, please access the report “Meltdown or Melt-up?” at gss.bcaresearch.com.

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Are Low Rates Jeopardizing Financial Stability?

Excessive financial deregulation, rather than low interest rates, may be the primary cause of financial crises.

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Our Global Investment Strategy service argues that low interest rates may not have been the main contributing factor to past financial crises. For example, housing bubbles in the Nordic countries in the late 1980s occurred against a backdrop of high interest rates, while persistently low interest rates in the U.S. in the 1950s and 1960s failed to generate asset bubbles or out-of-control credit booms.

Rather, rapid financial deregulation may have been the reason behind prior crises. Encouragingly, the thrust of recent legislation in the U.S. and many other developed economies has transformed banks into the equivalent of well-regulated utilities. This implies lower rates of return on equity and assets for investors, but also diminished risk of massive losses.

As discussed in the next Insight, low interest rates are not generating the same sort of distortions in the real economy as they did during prior stock market booms.