Border Adjustment Tax DOA as Retailers and Traders Celebrate Victory

Republicans have officially given up on trying to pass a border adjustment tax to even the playing field with our trading partners. The Retail Industry Leaders Association celebrated the news and said they are now ready to get on-board with the President’s tax reform.

The retail sector, and stock traders, won a significant victory Thursday when the White House and Congressional leaders announced that they have set aside a border adjustment tax that could have raised the cost of imported products by up to 20 percent.

Republican leaders said on Thursday that the proposed border-adjusted tax won’t be part of negotiations on how best to overhaul the U.S. tax code, giving a victory to retailers’ and stock traders that had opposed the measure. Retailers said that a BAT would be passed on to consumers.

For stock traders, this is a big win because 75% of GDP comes from consumer spending at the retail level. A border adjustment tax basically would play out as a consumption tax which would reduce consumer spending. You raise taxes and can do things like a border adjustment tax in a strong economy with runaway inflation where you’re trying to cool off the economy and so fiscal and monetary policy support each other. In a weak economy with flat wages and struggling consumers, you lower taxes and do things that increase consumption. We are in a weak economy and so a border adjustment tax right now would have hurt the economy and thus job growth.

Border Adjustment Tax Impact On Consumers

Some traders told me that if costs of a BAT were passed on to consumers then that would be inflationary and help the Federal Reserve achieve their 2 percent target. The problem with that logic is that what if it didn’t work? I mean it’s only inflationary if someone is willing and able to pay the higher prices caused by a BAT. What if consumption instead contracts as a result of higher prices? If demand contracts then supply contracts and that would work against supply-side economics.

A statement Thursday from House Speaker Paul Ryan, Ways and Means Chairman Kevin Brady, White House economic advisor Gary Cohn, Treasury Secretary Steven Mnuchin, Senate Majority Leader Mitch McConnell and Senate Finance Committee Chairman Orrin Hatch said that due to the unknowns associated with the border adjustment tax, they had decided to set this policy aside to be able to advance tax reform.

For stock traders this is a big win as tax reform will lower our capital gains tax and allow us to invest and trade even more. Anything that advances tax reform is a win for traders. We are very close to going into a Bear market unless President Trump’s agenda moves forward IMO.

Larry Kudlow said on CNBC:

BAT was holding things up and we buried that several times and it kept coming back… Small businesses are going to get a tax cut, that was a very important part of the Trump plan. They talked about expensing and will have unprecedented write-offs, this is very important from a cost of capital viewpoint… Repatriation is going to be in here… Unlike health care, on taxes the Trump Administration had its act together and secondly, the Republican party basically agrees with itself.

Pitched as a major revenue source in a Republican-backed tax reform program, the border adjustment tax was touted as a key to returning manufacturing jobs to the U.S. by making imported products less competitive.

Ryan and Brady, who spent over a year championing the border adjustment tax, told Republicans prior to the statement’s release that the concept would no longer be part of tax-legislation negotiations.

Target called the leaders’ joint statement a step ahead for tax reform.

By eliminating the BAT, the way has been cleared for swift action on a middle-class tax cut which will put more money in the wallets of the American taxpayer.

BAT would shift the supply curve inward as demand would drop as prices rise. Supply-side economics seeks to do just the opposite, to push the supply curve outward, not inward. Republicans taking BAT out of the tax reform bill is a victory for retailers and the economy.

I’m so happy to hear that Speaker Paul Ryan and Ways and Means Committee chairman Kevin Brady have decided to set the border adjustment tax aside and not include the controversial tax in tax-legislation negotiations. I think we finally have a chance at the first comprehensive tax reform in more than 30 years. However it leaves a question as to how to pay for these tax cuts. The BAT would have raised more than $1 trillion over a decade, according to estimates. A BAT would have helped pay for tax cuts for everybody. The problem though is that with a BAT included in tax-legislation negotiations, there’s no way tax-legislation would have passed. It was a catch 22.

Without BAT revenue, it is going to be more difficult for Republicans to keep the tax cuts permanent and to produce the kind of tax cuts that President Donald Trump has promised. Under the budget rules that GOP leaders plan to use, any tax-legislation changes that increase the deficit can only be temporary.

I think that the Federal Reserve should sell-off its balance sheet and use that money to send to the Treasury to pay for tax cuts. Have the Federal Reserve do something that’s good for the American people and main-street instead of always focusing on what’s good for Wall Street. We could corner the debt on the balance sheet of the Federal Reserve instead of the Federal Reserve spending our tax dollars and then leaving the debt cornered with the public. I’m just throwing that idea out there. That’s what we have to do. We need to come up with creative and alternative ways of paying for big permanent tax cuts.

Congressional tax writers will need to consider multiple ways of raising revenue to pay for tax cuts from various businesses by closing loopholes.

Here’s an idea. Let’s push NASA to advance the space-mining industry and then any proceeds gained from NASA mining an asteroid would go to pay for tax cuts. Just one asteroid mined could be worth trillions of dollars in tax cuts.

If you have any creative ideas for how to pay for a big permanent tax cut, leave your comments below.

FOMC Announcement Pushed US Dollar Down Big Time

The dollar did a big drop today after the FOMC announcement left rates unchanged. The Federal Reserve said the reduction of the balance sheet will begin relatively soon. I think relatively soon means September 2017.

The Fed seemed to indicate that “gradual” policy tightening will continue.

The Federal Reserve will begin winding down the stimulus program it embarked on to save the economy from the financial crisis. As expected, the Fed unanimously declined to raise interest rates.

The Fed predicts inflation will stabilize around the Committee’s 2% objective over the medium term despite inflation being below 2% in the near term. The Fed said they continue to expect “gradual increases in the federal funds rate”.

Fed Announcement Pushed Down the US Dollar

What the drop in the US dollar is telling us is that the Federal Reserve is dragging its feet. Just a few months ago, the Fed suggested we would get a rate increase in September. Instead, the Fed has backed off of that and now is toying with the balance sheet. The Fed seems to be telegraphing that it wants to slow down on tightening if inflation and wages don’t play out the way that they expect. I think the low inflation rate and low wage growth is really bugging the Fed because inflation should not be this low, at this time, in the economic cycle. Without a threat of runaway inflation, I think the Fed now feels that there’s no reason to rush another rate hike. This is all dovish which explains why the US dollar took a big dump today.

The FOMC announcement suggests they will begin quantitative tightening (QT) in September as they begin rolling off the $4.5 trillion portfolio of bonds it has accrued on its balance sheet, largely in the years after the crisis and the Great Recession. Balance sheet reduction is really the new QT as explained here.

The committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the market evolves as expected.

The Fed also offered a bit more information on the balance sheet reduction strategy. Having ballooned to $4.5 trillion thanks to QE, the Federal Reserve has already announced a strategy of gradually limiting the reinvestment of proceeds of maturing assets. The question has been the timing. This statement suggests it will begin “relatively soon”, whereas previously they had merely stated it will start this year. I think traders are pricing in a balance sheet reduction to start either in September or October. Efforts will entail allowing a restricted level of proceeds from the bond portfolio to run off. The program will begin at $10 billion per month and increase to $50 billion. Fed officials estimate that once the program has run its course, the balance sheet will probably still exceed $2 trillion.

Chair Janet Yellen and many others have suggested that the balance sheet runoff should not be disruptive to markets, though it’s possible that QT may push up rates if demand for the bonds the Fed is rolling off are not absorbed by private markets and central banks in other countries. However, we do not see any sign of that happening yet.

Janet Yellen really tried to downplay the planned balance sheet reduction last month.

The other big focus in Wednesday’s FOMC announcement was the Fed’s perspective on inflation. The core personal consumption expenditures index has dropped away from the central bank’s target for the last four months. The softer inflation figures together with the probability of a September balance sheet reduction means that December is likely the next month the Fed will consider hiking rates.

General inflation, excluding energy and food prices, has declined and is running under 2%.

Fed Board Chair Janet Yellen told Congress that temporary variables like prescription drugs and cheaper cellphone programs were behind the inflation downturn.

Markets didn’t expect the Fed to increase rates at this meeting. Dealers from the fed funds futures market are assigning about a 50-50 chance the central bank does one more rate hike before the year’s end.

In assessing the economy, the FOMC announcement showed that the committee held to its assessment that action was rising moderately so far this year. On inflation, the statement removed the word “somewhat” from June’s verbiage and said simply that inflation was running “under two percent,” a subtle tweak which nonetheless probably signifies officials are somewhat more cynical about reaching their mandated objectives.

Average hourly wage growth was stuck around 2.5 percent. Other inflation measures are even lower, with the Fed’s preferred estimate, the personal consumption expenditures index, at 1.4 percent.

Looking further ahead, we are still on with the prediction for two rate increases in 2018, anticipating reasonable 2-2.5% GDP growth over the next year and a likelihood that inflation will slowly return to target, helped by a tight labor market and the possibility of a gradual uptick in wage growth.

If you have any thoughts on the FOMC announcement feel free to comment below.

Here is the full FOMC announcement.

FOMC Announcement

Information received since the Federal Open Market Committee met in June indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have been solid, on average, since the beginning of the year, and the unemployment rate has declined. Household spending and business fixed investment have continued to expand. On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

For the time being, the Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated; this program is described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Neel Kashkari; and Jerome H. Powell.

Corporate Bond Yields Spread Falling… Another Bullish Indicator

Corporate bond yields spreads are falling which suggests there is a low default risk. Using Fred and Moody’s we can chart the spread between lowest investment grade (Baa) and equivalent 10-year Treasury yields.

Corporate Bond Yields Spread Chart

Corporate bond spreads are at there lowest point since 2008. This suggests that markets are pricing in a very low risk of default which is bullish for the economy.

BAA Corporate Bond Yield

Corporate Yield of a Moody’s Graded Bond. For instance, a Seasoned AAA Corporate Bond of 30 Year is the yield return of bonds graded AAA by Moody’s with a maturity of 30 years. Bonds less than specified timetables are dropped along with bonds with redemption and rating risks.

Moody’s BAA corporate bond yields are instruments based on bonds with maturities of 20 years and above. For instance, a seasoned BAA corporate bond of 30 Year is the yield return of bonds graded BAA by Moody’s with a maturity of 30 years. Bonds less than the specified timetables are dropped along with bonds with redemption and rating risks.

The credit ratings of AAA and BAA are the two ends of the ratings spectrum for investment-grade corporate bonds as provided by the Moody’s rating agency. The yield difference between bonds with these ratings has historically indicated whether the economy was in a period of recession or expansion.

The credit-rating agencies Moody’s and Standard & Poor’s provide credit ratings on bond issuers and their bonds to give investors an idea of the investment reliability of the bonds, concerning the payment of interest and principal. AAA is the highest bond rating and indicates the safest bonds for investors. Bonds rated below BAA — BBB from Standard & Poor’s — are considered to be non-investment grade. That makes the BAA rating the lowest investment grade rating. The lower the credit rating, the higher the yield a bond will pay.

The corporate bond yields spread chart above shows riskier BAA rated bonds (lowest investment grade rating), versus 10-year Treasury yields. In periods of higher default risk, the plot rises. The plot falls in periods of lower default risk.

U.S. Treasury yields are falling because of low inflation. With inflation so low, the Federal Reserve will likely not raise interest rates again until 2018. Remember, the main reason the Fed raises interest rates is to combat inflation in an over-heated economy. Clearly we do not have that.

Tax cuts and a $1 trillion infrastructure spending program would push inflation higher.

With Congress failing to repeal and replace ObamaCare, it is pushing the Trump Administration’s tax cuts and infrastructure jobs program out further. Inflation is staying low for longer as a result.

The Federal Reserve now is in a position where they do not need to raise rates to combat inflation. As a result, the Fed funds futures rate has dropped and is now showing about a 40 percent chance of a rate hike in December 2017.

Next week when the Fed meets, we could get clarification on when they will begin unwinding their $4.5 trillion balance sheet.

If you have an opinion on what the drop in corporate bond spreads means, please add your comment below.

Janet Yellen Testimony Economy Strong Enough For Rate Hikes

The US economy is healthy enough to absorb gradual rate increases and the reduction of the Federal Reserve’s balance sheet, Fed Chair Janet Yellen testimony before Congress on July 12, 2017.

Federal Reserve Chair Janet Yellen told Congress on Wednesday that the bank hopes to keep raising a key interest rate and also intends to begin this year, the reduction of its bond holdings.

Yellen took note of several factors, such as household wealth and job gains that she said should fuel growth.

In what could be one of her last appearances on Capitol Hill, Yellen portrayed a market that, while growing gradually, continued to add jobs, gained from continuous household consumption and a recent leap in business investment, and was currently being supported too by stronger economic conditions overseas.

She blamed the economic slowdown in the first half of 2017 on inflation. She said Fed officials are watching developments closely to be certain price gains go back toward the 2 percent inflation target of the Fed.

Janet Yellen Testimony Freak Out Over Inflation

Janet Yellen seemed a little freaked out over the big drop in inflation over the last few months.

I take Yellen’s comments on inflation to mean that the economy should not have the CPI plunging in this part of the economic cycle. In fact, just the opposite should be occurring. But she added that it was considered by officials as an anomaly; inflation is predicted by the Fed next year.

Many economists believe the Fed, which has raised rates three times, will increase rates yet another time this year.

The Fed continues to anticipate that the development of the market economy will justify gradual increases in the federal funds rate over time while reductions in the Fed’s holdings of more than $4 trillion in securities will probably start “this year”.

In her prepared testimony before the House Financial Services Committee, Janet Yellen testimony repeated the message she’s been sending: the market has improved enough that it no longer requires the support the central bank began providing in 2008 in the aftermath of a serious financial crisis and the deepest recession since the 1930s.

In light of the continuing expansion, the Fed plans to keep raising its benchmark rate of interest and to lower its investment holdings, Ms. Yellen said in prepared testimony. She did not offer details concerning the time of the next actions of the Fed. Analysts expect the Fed to begin shaving its bond portfolio before the end of 2017.

The economy began the year with a slow growth rate of just 1.4 percent, it has regained momentum in recent months, aided by strong job gains, a revival of business investment and a strengthening of international markets.

Bottom line: the market is at full employment and the Fed is moving rates. As the Fed reinvests some of the bond holdings which mature monthly, they will decrease that reinvestment to reduce their balance sheet which will mark the beginning of QT (quantitative tightening). Many believe that QT began this year when the Fed did a series of rate hikes.

The Fed needs to keep policy accommodative to keep on supporting the recovery, but may hit a “neutral” rate quicker than anticipated. Estimates are that inflation has been dropping so fast that we could be near zero right now. Yellen has said the Fed expects estimates of the inflation rate to grow over time.

Yellen said in her testimony that as it stands rates “might not need to rise all that much farther” to reach neutral.

Yellen said growth remains moderate with business investment and consumer spending picking up, and the US economy is benefiting from growth in other countries too.

A strengthening in economic development abroad has provided significant support for U.S. manufacturing production and exports, Yellen said.

The Fed slashed its key policy rate to near zero to fight the worst economic recession since the 1930s, and kept it there for seven years before nudging it higher in December 2015. It left the rate unchanged before increasing it again in December 2016, March 2017, and June 2017 of this year.

At its June meeting, the Fed indicated that it expected to start decreasing its $4.5 trillion balance sheet after this year, a measure that could put slow upward pressure on longer-term prices for such things as home mortgages.

Yellen said, the market seemed to be in a virtuous loop of hiring, investment and spending which should increase resource usage somewhat further, thereby fostering a quicker rate of wage growth and price increases.

The Janet Yellen testimony was fairly uneventful except for her comments on falling inflation which seemed to baffle the Fed as to why this was happening at this point during the economic cycle.

Jolts Job Openings Down But Hiring Up

The JOLTS Job Openings report showed U.S. companies posted fewer job openings in May but hiring picked up and people are quitting their jobs — both bullish signs for the economy.

New government statistics show American companies have made progress filling their record number of job openings, as hiring rose in May while the amount of job openings in the labor market dipped to just shy of 5.7 million.

JOLTS Job Openings

There were broad increases in professional, retail, and business services. That narrowed the gap between job openings and hiring, which had raised concerns of a skills mismatch in the market.

JOLTS job openings dropped 5 percent in May to 5.7 million, the Labor Department said Tuesday. Meanwhile, hiring rose 8.5 percent to just under 5.5 million.

The hiring rate rose two-tenths of a percentage point to 3.7 percent.

The Bureau of Labor Statistics’ monthly JOLTS job openings report — an acronym for Job Openings and Labor Turnover Summary showed openings in May dropped off to the lowest level since January.

The job openings dip in May shows further evidence that the economy is hitting the wall of maximum employment.

This JOLTS job openings report is a sign the market at 4.4 percent unemployment is nearing full employment when almost all people who need a job have one and the unemployment rate mainly reflects the normal churn of people that are temporarily out of work. Usually when unemployment drops this low, companies have to offer more pay. I think faster wage growth is coming.

As the bull economy ages, there is going to be fewer available jobs out there simply because companies have hired all the workers they need for now.

Hiring, meanwhile, surged north of 5.4 million to the highest level the market has seen since December 2015. Substantial upticks in hiring from business and professional services, and educational services, resulted in 25,000 and 121,000 more employees than the month before.

The JOLTS report is among the data watched by Federal Reserve officials as they track both inflation and the labor market.

Quits are typically regarded among analysts as a sign of optimism that employees feel good about their choices.

The amount of people quitting their jobs has increased 7.1 percent to 3.2 million. People usually quit when they either find a new job, often at higher pay, or are convinced they will be hired elsewhere. Quits gauge workers’ willingness to depart present positions in search of higher wages. Coupled with increased hiring across sectors, the equally broad-based increase in the quit rate bodes well for continued wage gains.

Average hourly earnings have failed to break above 2.5 percent on a year-over-year basis. Economists say a growth rate of between 3 and 3.5 percent in salary is needed to bring inflation near the Fed’s 2 percent target.

Layoffs were also up in May at nearly 1.7 million, tying March for the second-worst month so far this year. That’s still a respectable level at this stage in the economic recovery, but layoff upticks were seen across many different industries such as education and health services. Still, current job growth is more than enough to absorb the uptick in layoffs.

Interest Rate Policy May Be Too Tight As Evidenced By Inflation

The Federal Reserve shouldn’t be tightening policy with the evidence so clear that it’s falling well short of its inflation mandate. The interest rate policy is wrong because their math is wrong.

Right now the Fed’s inflation goal is 2 percent. Why so low? Fed rate hikes are keeping inflation too low and possibly will lead to the next recession.

Central bank officials are being too vigilant against an inflation problem that doesn’t currently exist.

When the next downturn hits, there will not be much of an inflation safety margin against deflation.

The US has had interest rates at near zero for nearly seven years. When the next recession hits, rates will fall back to zero again like they do during almost every recession. Is the central bank’s interest rate policy meant to keep rates stuck near zero for 7 years? No. So the logic behind a 2 percent target is wrong. If a 2 percent target doesn’t get rates high enough to keep them away from zero, then maybe a 4 percent one will.

Capital expenditures are very low, so most of the increase in debt was returned to shareholders, either in the form of M&A or stock buybacks. The increase in debt suggests that companies find borrowing cheap because interest rates are low. So money is easy, but demand is not very strong. Demand for products will continue to fall as the Fed hikes rates and makes borrowing more expensive.

Interest Rate Policy Is Too Tight at 2 Percent Inflation Target

Credit-card users, home-equity borrowers and homeowners with adjustable-rate mortgages, auto loans, all will likely see their monthly payments rise as the Federal Reserve’s interest rate hikes ripple on the other side of the economy.

The flattening yield curve seems to be saying rates are nearing a peak. The decelerating inflation rate as well as the slowing loan origination markets are signaling that Fed policy is a bit too tight. If policy is already too tight now, when the Fed begins reducing its balance sheet in a few months things will get even tighter.

You can think of the yield curve as a gauge for how far away the Fed is from completing its rate hike cycle. The fed funds rate is currently around 1.16%. The two-year is 1.35%. This suggests the market thinks there is one more rate hike coming. But the five-year is at 1.77%, which suggests the market doesn’t think interest rate policy will reverse in the coming years.

Why the Inflation Rate Could Crash the Economy

The inflation rate is too weak for a June Fed rate hike. According to a report in Reuters (link above), inflation expectations are falling fast.

Inflation Rate

The reason inflation is falling is from Fed rate hikes. That’s what hikes do. The Federal Reserve usually hikes rates into an overheated economy with prices running rampant. Businesses raise prices because there is so much money in the economy that consumers keep consuming regardless of what it costs. Rate hikes slow down economic growth and thus rising prices.

The CPI shows that we have been in a period of deflation since February.

The Fed hiked in December 2016, then again in March 2017, and now markets are betting they will do it again in June. Didn’t the Fed say that the pace of rate hikes would be gradual? I suppose “gradual” is a subjective term like most everything else the Fed says.

Where is the catalyst for economic growth going to come from that will absorb all these hikes? With the republican economic agenda practically derailed by Democrats and with the government running out of money fast, I don’t see it.

Stock Market at All time Highs! Are We In a Giant BUBBLE?

With the stock market hitting all-time highs, everybody wants to know if we are in a giant bubble.

You can’t trade and make money if you’re not in the market. If the fear that we are in a bubble is keeping you out, then you’re not making money.

The honey badger doesn’t care. The honey badger loves to climb walls of worry.

You can get an early read on which way the market is headed by tracking transports. Fedex is a bellwether stock in the transports industry.

The chart of FedEx just did a breakout above 180 and hit a new high. The rising Twiggs Money Flow shows FedEx is under heavy accumulation.

Remember folks, bull markets don’t die of old age, they are murdered by the Fed.

The chart below shows profit margins [blue] are falling as employee compensation [brown] rises.

Since 2015, employee compensation has started to recover as the labor market tightens and corporate earnings are falling (as a % of Net Value Added).

If you look back to the 1960s, you can see that when the labor market reaches capacity, profits fall as labor costs rise. The Federal Reserve intervenes to battle inflation from rising wages which will cause the next recession. The Fed does not usually intervene in a meaningful way until wages rise above 74% of corporate profits. In other words, we have a long way to go regarding rising wages before the Fed is going to hike rates so high that it causes the next recession.

Financial Education posted this video on if we are in a giant bubble. While I don’t agree with everything he says, he does make some good points IMO.

Inflation Expectations On The Rise Shifts Aggregate Demand Outward

Inflationary expectations are the expectations that consumers have concerning future inflation. If buyers expect higher prices in the future, they increase their demand in the present. This shifts the aggregate demand curve outward (to the right) which is good for the economy. For example, if the price of a house is expected to be higher next year, consumers decide not to wait, but to buy now. The increase in inflationary expectations causes an increase in consumption expenditures and subsequently an increase in aggregate demand.

Inflation expectations are on the rise in the U.S. which increase the possibility of a Federal Reserve rate hike soon.

Institutional traders and money managers are increasingly moving to hedge inflation risk in their portfolios by buying the iShares TIPS Bond ETF.

Are Inflation Expectations Really That Important?

A common question I get is if inflation expectations are that important. The answer is yes, and we can look back at history to see why. During the 1970s the importance of inflationary expectations as an aggregate demand determinant was revealed to economists. During the 1970s, inflation rates kept rising. The government deployed contractionary fiscal policies, but inflation continued to rise. The reason inflation kept rising is that the public “expected” it to. Once economists determined what was going on, manipulation of inflationary expectations was used during the 1980s to reduce inflation and to keep it low throughout the 1990s.