“Modest or nonexistent inflationary pressures should forestall aggressive tightening of monetary conditions.In due time, reasons will be conjured against reducing central bank balance sheets if and when interest rates threaten to exceed inflation by a wide margin.Very imprecisely, or rather, very impressionistically, Fed funds should not move beyond 2% nor should 10-year Treasurys exceed 3%, barring significant changes to labour costs and/or commodity prices.
Near term, central banks have shown a strong determination to normalize rates. The dramatic rise of stock prices and income-producing real estate, along with the markets’ extreme complacency (as measured by historically low volatility), have reawakened an old central bank nightmare, that of a highly damaging boom-bust cycle. They feel it is better to snuff out boom conditions now by reintroducing fear and a heightened sense of risk, thus disturbing this widespread complacency. Our inflation scenario provides us with the assurance (as assured as we can ever be) that the rate-rise phase engineered by central banks will not last long.”