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Monday, March 23, 2015 1:08 PM

Idle (and Extremely Late) Threat of the Day by Fed's Bullard: Raise Rates or Face ‘Devastating’ Bubbles

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The laugh of today comes from Fed non-voting member James Bullard who says Raise Rates or Face ‘Devastating’ Bubbles.

The US risks inflating asset price bubbles with “devastating consequences” if it leaves interest rates at zero, according to a senior Federal Reserve official.

James Bullard, head of the Reserve Bank of St Louis, told the Financial Times on Monday the Fed “should get on with normalisation” as soon as possible so that it does not have to raise rates more aggressively later causing significant market volatility.

The unemployment rate dipped to 5.5 per cent in February, its lowest rate since 2008, and was poised to go below 5 per cent by the third quarter of the year, Mr Bullard said.

Recalling the tech bubble in the 1990s and the housing bubble of the 2000s, he said: “Zero [interest rates] is too low in that kind of environment. I wouldn’t be comfortable with that. A zero rate would feed into an asset price bubble”.

When asset bubbles start, they keep going until they blow up out of control with devastating consequences.”

The policy maker dismissed the softer US economic data that has emerged so far this year as temporary and said that the current low inflation was caused by cheap energy prices and would move up once the oil market stabilised.

He said that the dollar was unlikely to soar much higher when the Fed raised rates as markets had already priced this move into the exchange rate.

Growth, he added, was likely to be running about 1 percentage point above its long-run trend and this would continue to push unemployment down towards the 3.8 per cent low of the 1990s and the 4.2 per cent low of the 2000s.
How Many Ways Can One Person Be Wrong?

I agree with Bullard that asset bubble blowups have enormous consequences. The problem is that Bullard apparently does not realize we are already in one of the biggest asset bubbles in history.

The asset bubble has already been fed.

As far as growth running above trend, Bullard is in outright Fantasyland.

Whereas Bullard says the current weakness is "temporary", I confidently predict a recession. It would not surprise me in the least if the US is already in one.

Powder Keg

Bullard said he was not especially concerned about the high prices already in bond markets because central banks had the tools and the communication abilities to soothe concerns in these areas.

Bond markets already have very high prices and low yields. You could wonder whether that’s a powder keg ready to explode, but central banks conduct policy so we can mitigate these concerns.”

Just like the Fed mitigated the dot-com bust and the housing bust? Do central banks conduct policy to mitigate bubbles or cause them?

Squirrels and Blind Nuts

Proving that even a blind nut is not always squirrely, Bullard did say something I agree with: Bullard said that the dollar was unlikely to soar much higher when the Fed raised rates as markets had already priced this move into the exchange rate.

On second thought, Bullard is likely to be right about the dollar primarily because the Fed is not going to get in as many rate hikes as the market has priced in.

Mike "Mish" Shedlock

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