Kroll Bond Rating Agency (KBRA) has released a new research report entitled “Inflation: The FOMC Chases Perception.” The report makes the following key points:

  • Looking at the current levels of inflation, growth and credit demand, it is not apparent that the Federal Open Market Committee (FOMC) can really justify a 3% target level for federal funds. The rate of change for the effective federal funds rate has been below the rate of change for GDP since 2008. Indeed, looking at the performance of the U.S. economy since the financial crisis, during which time short-term interest rates have been at or close to zero, KBRA wonders where GDP will be and when the target rate for fed funds reaches 3%.
  • While investor fears regarding future inflation initially pushed Treasury yields higher, optimistic investor expectations of future growth have caused equity benchmarks to reach new highs and high-yield bond spreads to tighten. Indeed, none of the traditional economic indicators are providing a clear indication of what lies ahead for the U.S. economy. Higher interest rates already suggest a significant slowdown in the U.S. housing sector in 2017 and beyond.
  • KBRA remains skeptical that the FOMC will actually be able to reach a 3% target for federal funds in the timeframe described by Chair Yellen. While the movement of benchmark interest rates may suggest heightened inflation fears, and justifiably so given the statements from President Trump, KBRA remains far more concerned about the level of demand in the U.S. and a surging dollar. Raising interest rates without a clear indication of a strong recovery in terms of demand for credit runs the risk of putting the U.S. economy into a stall. We particularly worry the reflexive upward movement of Treasury yields following the November election may not be an accurate indicator of future inflation.

To view the report, please click here.

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About Kroll Bond Rating Agency

KBRA is registered with the U.S. Securities and Exchange Commission as a Nationally Recognized Statistical Rating Organization (NRSRO). In addition, KBRA is recognized by the National Association of Insurance Commissioners (NAIC) as a Credit Rating Provider (CRP).