Capital Markets

Friday July 19, 2013**************************************** By Lou Barnes Relax, everybody. The Fed follies are over for now, for weeks and maybe months. Interest rates won’t do much until we get a stream of data either confirming or denying the Fed’s relatively rosy forecast. The economy is in no danger of “overheating” into inflation, and the greater risk is still on the stall side. Give yourself a soft summer moment to look backward, not in anxiety, but to mark the ever-so-gradual transition toward normality — and the period we have survived. Normal… in normal times the 10-year T-note yield has tended to be about 2% over inflation, and/or about the same as nominal GDP (not inflation-adjusted). “Core” inflation today is running about 1%, which would lead to a 3.00% 10-year, and the Fed’s Aunt Blappys in the last 60 days have gotten us almost there, right or wrong. GDP is trickier (a lot): the Fed forecasts 2.6% real GDP for 2013, plus 1% inflation would equal a 3.6% 10-year. The IMF has US GDP one full percent below that, therefore the 10-year fully corrected right now. If GDP accelerates, then we can afford higher costs of borrowing. Only higher inflation is trouble, forcing the Fed to lean against the breeze. Where is normal for inflation? Perfesser Bernanke has insisted it will soon return to 2%, but offered no supporting analysis for a trend which no one else sees, inflation now headed down. The anti-QE yappers and their “Debasement! Money-printing! Inevitable inflation! Buy gold!” have been as wrong as wrong can be. One road to inflation is excessive credit; we don’t have enough. Another is cost-pushed, as in an energy-price shock; Gasland gasbags aside, fracking is an anti-inflationary boon likely to last decades. Perhaps the most reliable source of inflation is a wage-price spiral. That’s the great bugaboo left over from the ’70s. By 1990 foreign wage competition began to cap and then drive down US wages. The Lefties insist that the 1% did it, and the Righties claim wages would rise if we removed government, both totally mistaken. We might be at “risk” of too-fast wage growth when China reforms its economy away from excessive investment and production, or the whole emerging world closes on the US in productivity and wages. Good luck with those. We could enter new bubbles of some kind, requiring a period of Fed puncture. Some people are worried about a housing re-bubble, but it’s not in the numbers. We won’t know for months the damage brought by prematurely higher rates (my faith in Bernanke notwithstanding, “premature” is what this rise has been), and not for months beyond that if the housing spurt of the last year is more pent-up release than self-sustaining. Under current underwriting standards, the latter is impossible. Credit may improve faster than I think. Banks have been in a long process of re-capitalization, now in the second half. First the slow recognition of immense losses, then retaining earnings, then retaining earnings to new levels of capital, then forced to raise those levels. However, the political crimp on lending is going to last a long time — after the Great Depression it lasted 40 years. With crazy people like Jeb Hensarling (R, TX) and Elizabeth Warren (D, MA) in charge, ever-vigilant against government-assisted OR private lending, credit will not fuel inflation for a long, long time. You could spend a summer hour worried about other things. Syria, Egypt… but don’t. For the first time since Israel’s founding, other nations nearby are consumed by internal affairs. Hassan Rouhani is an unmistakable improvement and signal in Iran. You could worry about Detroit, and a series of municipal defaults. Don’t. I worked there 1972-73, and terminal decay was in plain sight. Worth studying, but not worry. You could worry about financial horrors in Japan and Europe, upon whose failure so many are betting so much. But anything that goes really wrong will just push more cash to the US 10-year and mortgages. Instead of all that angst, wish a victory lap for Perfesser Bernanke. He’s a great fan of baseball and deserves a tour like Mariano Rivera’s. Stop this market-dressing for your successor and take some high-fives, thanks for saving our sorry behinds.