Super-low real yields for longer is an anchor for the dollar - Socgen

Kit Juckes, an economist at Societe Generale, explained the basic premise of the Kiley/Roberts paper.

Key Quotes:

"The basic premise of the Kiley/Roberts paper is that if the 'neutral' real interest rate is as low as 1% (which is broadly what most analyses conclude), then the neutral nominal rate with a 2% inflation target is 3%. 

And if neutral rates in nominal terms are at 3%, rather than, say 6%, then the chances that rates ought to be below zero at some point in the economic cycle are high. Which, in turn, causes a huge problem if the zero lower bound makes getting inflation back up to target in economic downturn harder. And that creates a risk that inflation will be below target and output below potential more frequently, risking a vicious spiral as the central bank fails o get output back on trend. Hence the Bernanke solution - a deliberate policy of keeping policy too easy into an economic upswing, temporarily ignoring upside inflationary risks.

That is very similar to what Fed policy currently looks like. Old-fashioned measures of a potential output suggest that with the economy at or close to full employment (the weakness of wage growth notwithstanding), there isn't much slack left. So rates 'ought' to be headed to neutral (3% in nominal terms) pretty briskly. And yet, while the FOMC 'dot-plot' does get to 3% 'in the longer run', insouciance at the market pricing which undershoots the dots, and the tone of Fed commentary, both suggest that there is a deliberate bias not to rush.

My bigger beef with this whole way of looking at things is that if inflation isn't low because of Fed policy, but rather because we're in the middle of a major technological revolution that is keeping it down, irrespective of what's happening to unemployment or to demand, than the fed's ‘neutral' rate is neutral in a narrow sense but fuelling disequilibria in the financial sector, in asset markets and in the balance of payments for that matter. Hence a bias to think that super-low real yields will fuel over-correlated market prices, low market volatility and a general search for yield. They'll also (to get back the FX point) anchor the dollar."