U.S. Federal Reserve Chair Jerome Powell holds a press conference following a two-day meeting of the Federal Open Market Committee on interest rate policy in Washington on July 31.Kevin Mohatt/Reuters
John Rapley is an author and academic who divides his time among London, Johannesburg and Ottawa. His books include Why Empires Fall (Yale University Press, 2023) and Twilight of the Money Gods (Simon and Schuster, 2017).
‘It’s the stories, not the statistics” the president of the Boston Federal Reserve Bank, Susan Collins, once told me. It was long before her Fed days, and this self-confessed “data person” was making a statement of her economic philosophy that was both profound and prophetic – that data-driven policy only emerges from the stories we tell with the data.
On Thursday, Prof. Collins arrived in Jackson Hole, Wy., for the annual retreat of this most data-driven of central banks. Speaking to reporters, she warned that while the U.S. economy was in a good space, there was a danger that a narrative of “self-fulfilling pessimism” could take hold.
There’s a strange clash of narratives happening in the markets at the moment, one that was on full display on Friday. Bond and stock markets rallied sharply during Jerome Powell’s speech, even as the Fed chairman’s own remarks didn’t really bolster the narrative of sharp cuts.
It’s a dangerous clash of narratives, and the Fed would like to nudge that toward a resolution that is as painless as possible. Spoiler alert: The days of near-zero interest rates are not coming back.
At the moment, bond markets are priced as if a recession is imminent, with 10-year U.S. bonds yielding an interest rate under 4 per cent. Given that inflation is currently running at about 3 per cent, that delivers a real return of less than 1 per cent. Not only is that well below the historical average, but it raises the question why anyone would invest in a security whose real worth will take a lifetime – and a long lifetime at that – to double.
It would make sense if investors believed the economy was about to sink into recession and inflation was about to collapse, making bonds a safe haven. Yet stock investors seem to believe that earnings will continue to grow well as the economy continues humming. So what bond investors actually seem to believe is that the Federal Reserve will be cutting interest rates sharply and returning them to the levels of the previous decade.
However the story the Fed has been telling for months is that interest rates are coming down, but not by as much as bond investors think. While U.S. inflation has been low in recent months, longer-term trends suggest it may now remain closer to 3 per cent than the Fed’s target of 2 per cent, and may even tick back up. Meanwhile, even though the economy is softer than it was last year, it is still growing strongly, wage gains are continuing, jobs are being created and unemployment remains low.
Even this week’s revision to the jobs data, which revealed that nearly a million fewer jobs than initially thought were created last year, and which was seized upon by some as proof the economy was tanking, didn’t actually alter the big picture. Instead, it may show that U.S. productivity, which has outperformed its rivals’ recently, is even stronger than thought.
Although the Jackson Hole retreat is meant to be an opportunity for strategic reflection on monetary policy, its statements are carefully parsed by analysts for clues as to the direction of interest rates. In that respect, this year’s reiterated the story the Fed wants to tell – that the economy, while softening, is in good shape; that inflation, while slowing, isn’t yet beaten; that rate cuts are coming, but won’t be deep and swift unless the economy gets much worse.
In Mr. Powell’s Friday speech, he said the current policy rate left the Fed with ample room to respond to incoming data. In other words, it’ll move methodically. The realization will probably gradually dawn on the market that interest rates, while coming down, may remain permanently higher than they were in the period between the 2008 financial crisis and the pandemic.
In short, 2-per-cent mortgages are a thing of the past. If interest rates only come down slowly and moderately, prices in other markets will readjust until both reflect the new reality – the end of the cheap-money era. In that respect, Canada, which has led the United States in cutting interest rates, may offer a harbinger of what’s to come south of the border.
Since the fall in real-estate prices, which followed the sharp rise in interest rates back in 2022, prices have largely gone sideways (though with large variations across different markets). With real prices thus being eroded over time by inflation, affordability, which was knocked sharply backward by the higher cost of mortgages, is finally starting to improve once more as nominal incomes rise.
Thus, we may be looking at the end of the gravy train for investors but better times for households. In the end, therefore, the season we’re headed into may be neither the endless summer signalled by stock markets nor the deep winter signalled by bond markets, but a long autumn in which nothing dies but nothing bursts with life. Given the fondness Canadians have for both the fall and all things moderate, that may be something to which many of them can look forward.