Inconvenient energy fact

Mark Perry has a fabulous post today highlighting the extreme inefficiency which afflicts the solar power industry. It can be summed up in the following chart, but be sure to read the whole thing for all the gory details:

Modest Fed expectations fit with modest growth

Today's FOMC statement was pretty much as expected, to judge from the relative lack of reaction in the bond market. The market currently assigns a relatively high probability of a modest 25 bps hike in the overnight funds rate target at the June FOMC meeting, and a very low probability of another for the remainder of the year. This fits with the current economic growth climate, which remains modest. Second quarter GDP is likely to be much faster than first quarter (0.7%), according to the Atlanta Fed, but the underlying rate of real growth is unlikely to be much faster than 2%. 

The chart above says just about all you need to know about current expectations. The blue line is the current real Fed funds rate (about -0.6%), and the red line is the market' expectation for the average real Fed funds rate over the next 5 years. The difference between the two is quite modest—just over 50 bps—which suggests the market just doesn't think the Fed is going to do much more tightening after next month's meeting for the foreseeable future. I note that the blue line has moved up of late, and that reflects the fact that the Fed's target rate has moved up from 0.25% to 1.0% while core PCE inflation has remained relatively stable at 1.5 - 1.8%.

In many previous posts I've noted that the time to worry about the Fed being too tight is when the blue line equals or exceeds the red line. At that point the market is figuring that the Fed is done tightening because the economy is softening and at risk of recession. Currently that's not the case. But neither is it the case that the market expects much more oomph from the economy.

If the market were optimistic about growth, the gap between the blue and red lines would most likely be much bigger, and the red line would be much higher (real interest rates tend to follow real growth rates). That's not likely to happen unless and until Trump manages to achieve some meaningful tax and regulatory reform. For the time being, the world is on hold.

Trump's deal of a lifetime

The value of global equities, according to Bloomberg's index, will probably set a new record high this week of just over $73 trillion. (To avoid double-counting, Bloomberg excludes ETFs and ADRs from its calculation.) The U.S. market is within inches of its record high $26.8 trillion set two months ago. But it's not just the U.S. stock market that is booming: U.S. equities today represent almost 37% of the total, whereas they were almost 45% in early 2004. We are a smaller (but growing) piece of an even-faster growing global pie, and most of the growth is happening in the lesser-developed countries. China's equity market today is worth almost $7 trillion, which is 15 times greater than its value in early 2004 ($440 billion). India's stock market has risen by a factor of 7 since then, and now totals almost $2 trillion.

This surge in global wealth has almost certainly been driven by an expansion of global trade. 18 years ago China's exports to the U.S. were a mere $2.4 billion per month; they now average $32.5 billion per month. Over the same period, India's exports have exploded from a mere $300 million per month to now almost $3 billion per month. Trade is a win-win situation for everyone, with the world's poorest benefiting the most even as developed countries continue to prosper.

As the chart above shows, the volume of world trade has almost doubled over the past 17 years, and it rose 4% in the year ended last February. Most importantly, world trade volumes surged at an annualized rate of almost 12% in four months ending last February, an excellent sign that global economic fundamentals are solid and improving. It's not a coincidence, I suspect, that the value of global equities has risen almost 10% in the most recent four months.

As I and many others have noted, the most troublesome thing about Trump was his failure to understand how international trade works, and in particular his aversion to trade deficits, which any economist worth his salt knows are effectively meaningless. His apparent willingness to impose tariffs on Chinese imports posed a grave threat to international trade and prosperity. Two weeks ago Trump may have made the deal of his lifetime when he offered to forget about our trade deficit with China if the Chinese would in turn help us solve the problem of North Korea. He gave up something that was worthless in exchange for—we hope—a solution to the NoKo problem, which would be priceless.