"Kee" Points with Jim Kee, Ph.D.

Markets bounced back last week following the Fed’s comments alluding to further monetary policy accommodation (i.e. waiting to raise short-term rates) if warranted by weak US data. Weak data is not what we are seeing, by the way, and the Fed is projecting 2.5% - 3.0% real GDP growth in the US for 2015. Oil prices and the Fed have dominated the news lately, so I just wanted to make a few points on those topics for this short holiday week!

 

Oil: I would say that lower capital spending and hiring for the energy sector is a done deal for 2015, regardless of whether oil prices bounce back up or not. Capital spending (including research and development spending) in the energy sector is a function of oil price forecasts, and companies usually come up with a most likely, best case, and worst case scenario. It is one thing to make plans based upon a theoretical worst case scenario of oil prices falling into, say, the $50-$60 dollar range. It is quite another to make plans in the wake of that worst case scenario having actually occurred, as is the case today. That increases the probability attached to the worst case scenario, and  will result in a curtailment of plans from the 2014 level - even if oil bounced back up above $100!

 

The Fed: Markets continued upward throughout the Fed's tapering of asset purchases this year, and many are wondering if the same could happen if and when the Fed starts raising short-term rates. I agree with those who assert that the real issue is the Fed's influence on the regulatory burden that the credit markets and banking system have to deal with (La Jolla Economics). On the demand side, continued growth in the projected 2.5%-3.0% range will result in an increased demand for credit from individuals and businesses. The constraint will come from the supply-side: The banking system's ability to lend is constrained by either (1) reserves, or (2) capital requirements/lending restrictions. Since reserves in the banking system are pretty much at an all-time high, we know that reserves won't be the constraint. It is the capital requirements that banks have to meet, and the lending requirements that borrowers have to meet, that will determine whether or not growth will be thwarted on the monetary side. Recent loosening of lending standards for home buyers suggest that the Fed and other regulators are hearing the concerns that, even though monetary policy has been extraordinarily loose, lending requirements have been extraordinarily tight. Loosening those requirements and providing more regulatory clarity in general for the banking system would, in my opinion, off-set in a positive way any negative impact of rate hikes on economic growth.