«Common sense tells you that if you have free money, you're going to take higher risks than you would ordinarily.»
Richard Fisher is a hawk. In contrast to the majority in the Federal Open Market Committee (FOMC), the former President and CEO of the Federal Reserve Bank of Dallas would not ease monetary policy at the Fed meeting on September 18th. A lower interest rate would do nothing to counter the uncertainty among companies over the trade war between the US and China, he says. Nor does it provide any other benefits.
According to Fisher, the current monetary policy is not restrictive and there is plenty of cheap money. He sees no need for negative interest rates. He says that they are going to prove in monetary history to be one of the greatest mistakes ever made.
Mr. Fisher, the Federal Reserve will most likely lower interest rates further. Is the US economy not strong enough to handle an interest rate of 2%?
Consumption drives the US economy, and consumption is strong. The unemployment rate is at 3,7%, the labor participation rate, as well as real wages, have been increasing. Last and not unimportantly, the savings rate is very high. This gives workers a sense of comfort that even if there is a slowdown driven by manufacturing, they have something to draw on to continue consuming.
So the rate cut isn’t necessary?
No. It is not necessary. However, the market participants have it fully discounted. That creates a little bit of pressure.
How would you decide?
If I were still in the Federal Open Market Committee, I would vote against this rate cut. As – as I expect – will Eric Rosengren from the Federal Reserve Bank of Boston and Esther George from the Federal Reserve Bank of Kansas City.
Are you expecting more easing?
It depends on what happens with the economy. If the economy were in shape as it is today, the answer would be no. Because even if the Fed were to do something radical, like cutting a hundred basis points over the next couple of meetings, it would do nothing to relieve the anxiety businesses have from the trade dispute.
However, it would lower borrowing costs.
Money is abundant and cheap. If you look at the yield curve and the activity of businesses, no one is saying they can’t get access to cheap capital. Moreover, lower rates have negative effects.
Regional banks are suffering from low net interest margins. You cannot find a banker in America who will tell you they want lower rates. Nor can you find a business that thinks it would be helpful to them. According to the National Federation of Independent Business (NFIB), only 4% of the companies they survey – a historic low – are saying they don’t have access to cheap and abundant capital.
Lower interest rates could weaken the dollar.
When you hear complaints about the consequences of the strong dollar, they come from the S&P 500 companies. 40% of their earnings are from abroad. There’s no demand from the real economy, from the real business sector, from the underlying economy of the United States or the banking system for a rate cut.
How much is international monetary policy affecting monetary policy in the US?
Not much. However, the Fed has to take it into account.
What do you think about negative interest rates?
You can look at the market reaction after the ECB announcement last week. The euro weakened and bank stocks lost. The European bank index is the only index I can think of that is down since 2009. Negative interest rates do enormous damage to the banks and the credit system. They’re a fatal mistake. Negative interest rates are going to prove in monetary history to be one of the greatest mistakes ever made. No one can argue that they are successful. The only argument is that it could have been worse. But we can’t prove that.
How important is the dollar for the Fed in setting monetary policy?
The dollar is one of the many variables that’s not a dominant variable at the Fed and the deliberations of the FOMC. That is because it’s the Treasury’s purview.
Are we stumbling into a currency war?
I don’t think so. The dollar has been appreciating for almost five years now. If you look at financial markets in the US, equities have gone up and yields have come down in that period.
The inverted yield curve is sending a warning signal about the economy. How reliable is the indicator?
Global markets drive the yield curve. The fixed income markets in the US are the deepest and most liquid. Money is flowing to the US from Europe and Japan whereas no money is going from the US to countries with negative yielding debt. That keeps interest rates low.
So the inversion of the yield curve is more an effect of loose monetary policy outside the US than an indication of the state of the US economy?
Yes. It’s a looser monetary policy. Our monetary policy is very accommodative but it’s even more accommodative and looser in Europe.
Is this loose monetary policy causing bubbles?
You can see it in the equity markets. They’re overpriced relative to the underlying value. Common sense tells you that if you have free money, you’re going to take higher risks than you would ordinarily. At some point, we’ll have a reset in prices. The risk of a correction is severe.
Would the Fed step in?
The Fed would have to determine if equity prices were to ratchet down or have a correction or reset, and foremost whether it will impact the real economy.
What does history teach us?
We had a twenty percent correction in one day in 1987 and markets didn’t recover until the following spring. The Fed paused but then went about its business because it had no impact on the economy as it continued to grow. In 1962 there was a prolonged stock market correction, and yet the economy continued to grow. However, there are other cases where equity markets corrected, confidence was dampened significantly, and the economy slowed down.
Do you see other bubbles?
There is one in Germany. Real estate prices have gone through the roof relative to the norm. I see bubbles, and I worry about them.
Germany is on the brink of a recession. How important is its economy for Europe?
Germany is a crucial economy. France, Spain, and the smaller countries cannot replace the power of the German economy in the European equation.
A strong labor market is fostering wage growth. The Fed nevertheless isn’t worried about higher inflation rates.
The Fed looks at the core Personal Consumption Expenditure (PCE). It has been below 2% for months. The core Consumer Price Index (CPI) on the other hand is clearly above 2%. In the meantime, the Fed is mentioning more and more alternative inflation measures, like the trimmed mean the Dallas Fed calculates. When I left in 2015, I was the only one who talked about it. Now even the Fed-chairman refers to the Dallas trimmed mean. That indicates that they’re looking for some new measurement to try to validate what they hear anecdotally from businesses.
What are they hearing?
They are saying «Wait a minute. I do not see a 2% inflation. My labor cost is accelerating at 3 or 5%». For many companies, that’s the most significant cost factor, and then we’ve got the tariffs coming.
Are you worried about inflation?
We could have a surprise to the upside. However, I’m not that worried about inflation. It could quickly go above 2%, but I don’t think it’s frightening at this juncture.