Japanese Long Leading Index growth actually improved for a bit, before starting to sink, and it was not until 27 months after the first rate hike that the BoJ reversed course and cut, as shown by the red arrow, following a plunge in Japanese Long Leading Index growth.
Now, the shorter, dark blue line shows current U.S. Long Leading Index growth, with the black vertical line marking off the timing of the Fed’s December 2015 rate hike.
It’s interesting to see that it’s right in-between the other two, and while we’ll have to wait and see how it evolves, the chart suggests a reasonable chance that the Fed will find itself backtracking. But what does that look like if you’re out of ammo?
The point is that, for central banks in general, credibility is the most important asset, and even for the Fed, this next chart raises questions.
Here we have both the market-based and survey-based five-to-ten-year-ahead inflation expectations hovering around record lows.
It is notable that these numbers are much lower than during the Great Recession, but what’s remarkable is how much they’ve dropped since 2014.
This is about the Fed’s credibility in keeping inflation around its target, not in the next few years, but in the next decade. To cite St. Louis Fed President Jim Bullard, these inflation expectations are “a rough measure of Fed credibility with respect to its 2% inflation target.” Yes, there’s been a good correlation between crude oil prices and 5-year, 5-year forward inflation expectations, but it may have persisted for a reason. It may be because a plunging oil price could threaten lenders to energy producers and jeopardize the financial system. Simultaneously, falling oil prices may be seen as a symptom of rising recession risk, while also increasing the probability of deflation that naturally boosts real interest rates, stymieing the Fed and making monetary policy less potent. Of course, anytime the Fed’s perceived impotence increases, so does the disbelief in its ability to meet its inflation target, even in the longer run.
And this is not just about the Fed, which undertook a Grand Experiment of an extended ZIRP and QE. There are actually three grand experiments that are too big to fail, and yet they are at risk of failing.
Following the Global Financial Crisis, China launched not only massive monetary easing, but truly colossal fiscal stimulus that included pouring nearly one and a half times as much concrete in the three years ending in 2013 as the U.S. had in the entire 20th century. The resource bust that followed has sent deflationary shockwaves around the globe, and the repercussions are not over yet.