Gradually and Then Suddenly

Unemployment is near historic lows and companies report difficulty filling skilled positions. Yet wage growth remains flat and labor productivity has collapsed. The most accommodative monetary policy in history has somehow produced the opposite of what economic theory predicts: not runaway inflation and growth, but stagnation disguised as stability. Something in this picture doesn't fit.

• Companies aren't investing in productivity improvements or competing aggressively for workers, even though cheap capital is abundant and skill shortages are acute. The easier the path to beating earnings targets through financial engineering, the less reason management has to take the risk of real investment.
• Stock buybacks and pro forma accounting games allow companies to hit guidance targets without actually growing. Why take the risk of expanding operations or paying more for talent when stock price appreciation comes risk-free from financial engineering?
• The Fed created a system where playing it safe is rewarded more than taking productive risks. This is the predictable but unintended result of flooding the economy with easy money.
• As rates rise, companies will finally have incentive to invest in real growth and pay for talent instead of relying on financial engineering. But the market has no idea what comes next.
• Interest rate increases are supposed to suppress inflation, but in an economy where easy money has eliminated real investment and wage competition, tightening policy may accelerate both. Central banks are about to test a scenario they've never actually contemplated.