Issue link: http://palletcentral.uberflip.com/i/946815
Now for the Bad News: Inflation and Interest Rates Headed Higher Inflation and interest rates have been low for so long, that it is easy to believe that this wonderful situation could last forever. It will not. First inflation is already starting to heat up. Although inflation (as measured by the Consumer Price Index) was still running below 2% in early 2017, inflation approached 3% in late 2017 when oil prices rebounded. Wage rate increases appeared subdued (near 2% as well) despite the extremely low unemployment rate. But a recent survey points to a much tougher time in the labor market this year. The recent survey of small business owners pointed to challenges ahead. The level of unfilled openings hit the highest level since the late 1990s. As a result, small business owners plan to increase compensation to attract or retain employees. The planned increases in compensation is now at the highest level since 2005. Thus, wage and inflationary pressures are likely to build during this year. So, the next question will be what the Federal Reserve (Fed) will do as inflation heats up. The Fed has already started the effort to slow things down. The Fed did boost short-term interest rates last year. The 3-month T-bill is now at 1.4%. Given the current and expected growth this year, the Fed plans to boost short-term interest rates at least 3 times. Each boost will be .25%. I believe they will opt for a more aggressive posture and move rates up 4 times. This would put the 3-month T-bill at 2.4% next January. As inflation heats up, they will keep boosting short- term interest rates in 2019. Long-term interest rates (using 10- year Treasury bond as a proxy) are a bit more complex. Despite the 1% increase in short-term rates, long-term rates were relatively flat in 2017. Part of the reason is that global interest rates were so low, that foreign capital flowed into the U.S. bond market. Long-term rates are likely to move much higher over the next two years for two reasons. First, the Fed is reversing an aggressive action to buy long-term debt instruments (called Quantitative Easing-QE) that started when short- term interest rates hit zero. Between 2009 and 2017 the Fed purchased nearly $4 trillion worth of long-term securities. This helped to lower long- term bond yields. The Fed now plans to unwind that position by 2023. This will mean that the Fed will be selling about $250-300 million of long-term securities every year. This is like an increase in the demand for long-term credit. palletcentral.com PalletCentral • January-February 2018 31