For the near term, my baseline expectation is that our economy will continue on its path of growth at around 2 percent. To confirm that expectation, it will be important to see a significant strengthening in growth in the second quarter after the apparent softness of the past two quarters. To support this growth narrative, I also expect the ongoing healing process in labor markets to continue, with strong job growth, further reductions in headline unemployment and other measures of slack, and increases in wage inflation. As the economy tightens, I expect that inflation will continue to move over time to the Committee's 2 percent objective.If incoming data continue to support those expectations, I would see it as appropriate to continue to gradually raise the federal funds rate. Depending on the incoming data and the evolving risks, another rate increase may be appropriate fairly soon.
Will these conditions be met for Powell by the time of the next FOMC meeting in June? On one hand, the Atlanta Fed tracking estimate for Q2 is up solidly:
That said, the tracking estimate is famously volatile and could easily collapse after the June meeting. So while a hopeful sign, I would not take it for granted yet that Q2 GDP will come in at a 3 percent pace. And given that Powell views this rebound as an "important" signal, I suspect he will want to be more certain of the Q2 results than allowable by the data available on June 14-15.
Note also he is expecting "further reductions in headline unemployment and other measures of slack" to justify a rate hike. This echoes my recent theme that stagnating progress toward full employment should be something that stays the Fed's hand for the moment. Powell also identifies evolving risks as an important factor in the timing of the next rate hike. As I said earlier this week, I think FOMC members need to shift to a balanced risk assessment prior to hiking. They were closer in April than March on that point, but I still think will fall short in June. Or at best are balanced in June and thus can justify setting the stage for a July hike. Either way, Powell made clear that if the data holds, he would support a rate hike in the near-term.
Powell tempers the rate hike message with a reminder that the path forward is likely to be very, very slow:
Several factors suggest that the pace of rate increases should be gradual, including the asymmetry of risks at the zero lower bound, downside risks from weak global demand and geopolitical events, a lower long-run neutral federal funds rate, and the apparently elevated sensitivity of financial conditions to monetary policy. Uncertainty about the location of supply-side constraints provides another reason for gradualism.
Earlier in the speech Powell, while commenting on slow productivity growth, said:
Lower potential growth would likely translate into lower estimates of the level of interest rates necessary to sustain stable prices and full employment. Estimates of the long-run "neutral" federal funds rate have declined about 100 basis points since the end of the crisis. The real yield on the 10-year Treasury is currently close to zero, compared with around 2 percent in the mid-2000s. Some of the decline in longer-term rates is explained by lower estimates of potential growth, and some by other factors such as very low term premiums.
I suspect that ongoing low productivity growth will lead to further reductions in the Fed's estimates of the longer run federal funds rate. I further suspect that this, combined with Powell's other concerns that limit the pace of rate hikes, means the likely medium-term path forward will be more shallow than the Fed anticipates. In other words, given current conditions, the Fed is still likely to move to the markets over the medium-term even if markets have moved somewhat toward the Fed in the near-term.
Housing data came in strong this week, including a jump in home home sales:
The shift from multifamily to single family looks well underway. While I wouldn't exactly expect sales to climb back up to 1.4 million units, there is clearly room for more upside here given a long period of under-building and high demand for housing. The latter was confirmed by the strong numbers in existing home sales. See Calculated Risk for more.
Initial unemployment claims was once again your weekly reminder that if you are looking for recession, you need to look somewhere else:
But the durable goods data was mixed, with an OK-ish headline but a weak core:
This weakness is consistent with soft regional ISM survey data that foreshadow a soft national ISM manufacturing number for May (to be released next week). Manufacturing data is likely to remain weak until the impacts of lower oil prices and a stronger dollar (both reversing this year) work their way through the sector, hopefully (keep your fingers crossed) by later this year.
While I do not believe current manufacturing numbers are indicative of a US recession, I would not be eager to hike rates into manufacturing weakness either. Moreover, if I were concerned about low productivity, like Powell and other FOMC participants, I would not be eager to hike into the low business investment numbers suggested by the core durable goods figures. Tend to think that this argues against June.
Bottom Line: Fed officials believe the data is lining up for a rate hike in the near future. Ultimately, I think they pass on June. Strategically, July offers a lot to like. They can wait for a more clear view of the 2nd quarter. They can use the June meeting and press conference to set the stage for July. They can broker a compromise between hawks and doves. The former should be happy because a strong signal in June is effectively a rate hike, the latter because it becomes an easily reversed rate hike (by skipping July if necessary) and they can bolster their case for gradualism. And a July hike will end the belief that the Fed can only hike on meetings with press conferences. My personal preference is to delay until September, but I don't run the show. All of the above assumes, of course, that data and financial conditions hold.