Fed, Bonds & Interest Rates

Ben White had this to say about Fed appointments last week in his Politico “Morning Money” column:

“FED TALK – Look for the vice chair nomination to come fairly soon. Mohamed El-Erian remains in the mix but could also be a candidate for the New York Fed. John Taylor sounds like a no-go for vice chair. The White House is looking for a hard-core economist for the vice chair slot, given that with Jay Powell, Randy Quarles, and Michelle Bowman for the community banker slot, Brainard would be the only remaining economist.

“The White House could also look to fill all the remaining slots after Chair Yellen leaves, bringing the Fed board up to its full seven and giving President Trump a massive imprint on the make-up of the nation’s central bank.”

My colleague Bob Eisenbeis has just written on this subject. Bob’s distinguished career has included serving at the Fed under five different chairmen. Here is the link to his recent missive.

What do we know?

A year from now the central bank of the United States – the lender of last resort to the US banking system and therefore to the world – will be a very different assemblage of folks than we have been accustomed to. Ten years of QE 1-2-3 and near-ZIRP are over.

What else do we know?

The last ten years of financial tailwinds are giving way to headwinds. Note that one may sail forward against a headwind by tacking back and forth. The process is slow and requires hard work. That is different from the ease of movement experienced with a tailwind.

The US federal deficit ran high for the last ten years, and aggregate US debt under three presidents has increased by nearly $11 trillion in a decade. Meanwhile, the interest expense line item in the federal budget has been flat as interest rates remained low and US debt service was refinanced at low rates. That tailwind is over.

The tax reform bill will raise the authorization to borrow and to add $1.5 trillion to the deficit. This is incremental to existing deficit projections which are already rising.  The total interest bill will be rising. The total debt-to-GDP ratio is headed for 100% with the tax reform bill addition, a level that reminds us of the end of World War II.