Zombie Economies keeping Rates Down?

Macro Perspectives

The World Bank downgraded global growth to under 3%.

On that news, after a strong climb in U.S. yields the day before, the 10-year yield reversed, and traded back below 3% yesterday.

This was a recipe for higher stocks on the day - in this environment, bad news is good news. It takes the pressure off of the Fed to carry out a draconian campaign of aggressive rate hikes.

The Fed has been successful in guiding demand lower, but they can do nothing about supply.

The biggest structural supply shortage (oil) will continue to put upward pressure on prices. And the energy price input on the cost of living, and cost of doing business, will continue to be a primary headwind for broad economic activity.

I’ll stick my neck out: a further 35% rise in food prices would be a conservative estimate of where the inflation story is going.

Higher rates won't fix this stagflation conundrum.

The softening of demand that has taken place from the influence of markets (lower stocks, higher gas, higher mortgage rates), is the optimistic scenario. The pessimistic scenario is an economic crash induced by an aggressive global central bank tightening campaign (led by the Fed).

But as I said, the Fed doesn't have the tools to deal with the supply issue. So, contrary to what they say they're going to do, the Fed has no reason to aggressively raise rates. But they have reasons not to;

Despite seeing the hottest inflation in four decades for about a year now, the Fed still hasn't gotten the effective Fed Funds rate back above 1%.

Meanwhile, in Europe, the ECB still has the deposit rate at negative 50 bps. Yes, you have to pay the bank to keep your money on deposit. That's an incentive to spend, not save - that's not exactly the kind policy you would expect with the inflation rate in Europe running at 8%.

So, why aren't they raising rates?

This chart above shows the 12% U.S. fiscal deficit last year, which compounds the record U.S. debt. In short, the global sovereign debt markets can't handle it (i.e. higher rates).

Even if the U.S. could handle adding to record debt and a massive fiscal deficit, Europe could not. The zombie economies in the euro zone, which nearly defaulted 10 years ago, only to be saved by the backstop of the ECB, would surely go bust - the European debt, and then global sovereign debt, dominoes would fall from there.

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