Bond Market Observations: What Color Is Your Parachute?

When planning to jump out of an airplane, it is appropriate, downright prudent, to expect the law of gravity to operate. After all, it reliably explains why you will hurtle faster and faster to the ground. It is less appropriate, downright foolish, to assume automatically that the grayish-green backpack handed to you at the outset was a functioning parachute. A few questions are in order, such as, is this a bargain model, who packed it, and how long ago was that? After all, parachuting is all about acting on a theory—the chute will likely open—for which empirical support offers comfort and contrary evidence is unsettling.

The Federal Reserve is operating on the same principle as a hopeful parachutist. Policymakers delivered the second quarter-point hike of 2017 earlier this month, according to plan, and gave every indication of following through with their promised unfinished business of starting to reduce the size of the balance sheet and tightening the policy rate one more time this year. The Fed is acting on a theory, that an unemployment rate in the neighborhood of 4-1/4 percent presages inflation picking up to the Fed’s goal. For now, there is a discomforting downward tug of inconvenient facts. The same employment report that showed the unemployment rate ticking lower to 4.3 percent also reported three-month-average net job gains of 120,000, distinctly slower than earlier in the year. In general, incoming economic data across the major economies were less upbeat, with disappointments in store on net in the US and the UK. In-quarter tracking estimates of US real GDP growth, at around 3 percent or slower, deflate the notion of a rebound from the subdued first-quarter pace of expansion. Over the past month, both the US and UK proved their penchant for providing political drama, raising the odds of counterproductive economic outcomes. And core inflation over the past few months moved in the wrong direction for two central banks seeking to return to their price-stability goals from below, the Federal Reserve and the European Central Bank.

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