Fed Watch: Clearly Hawkish Signals

Here's the latest Fed Watch from Tim Duy:

This is something of an abbreviated piece today – I need to focus my attention on final preparations for the Second Annual Oregon Economic Forum. And, truth be told, Fed policy makers are taking some of the fun out of the game at this point with their clear warnings on inflation. Indeed, even “Mr. Eighth Inning,” Dallas Fed President Richard Fisher, who I had previously dubbed a dove, has delivered a series of market rattling comments. David Altig’s compilation of blogs from Mark Thoma and William Polley, among others, provides a great overview of this increasingly hawkish language that appears to point to only one thing – more rate hikes in the coming months. Indeed, this is the theme picked up in this morning’s Wall Street Journal. And incoming data and anecdotal evidence remain supportive of that path.

Probably the most important piece of data to arrive last week was the September labor report, which came in well above expectations with a 35,000 dip in payroll. As far as the Fed will see this report, I think David Altig hits the nail right on the head – it is somewhat of an uphill battle to paint the report in a bad light, especially considering some early guesstimates pointed to a payroll slide of 500,000. Simply put, the labor report will only be supportive of the Fed’s contention that the impact of Katrina and Rita on the demand side of the economy is minimal and locally contained. Consequently, the Fed will focus on the supply side impacts and their arch nemesis, the inflation beast.

What about the continuing troubles in the automotive and airline industries? Over the weekend, we saw the not-unexpected bankruptcy filing of the auto parts maker Delphi  (WSJ subscription). Will this rattle Fed officials? Doubtful. As I have argued before, this is part and parcel of the ongoing saga of the US auto industry – an industry whose profits depend upon a vehicle type fewer people want to purchase. Moreover, the industry’s labor woes are legendary. According to the WSJ, the UAW contract with Delphi provides workers with a wage-benefit package of $65 per hour, not exactly competitive internally, let alone internationally. Similarly, airlines are also caught in a structural straightjacket. High labor costs, high fuel costs, and relentless competition all conspire to force an ongoing shakeout in the industry, which some analysts believe will not be complete until an airline actually disappears and takes some capacity with it.

The short story is that Greenspan & Co. are not likely to take their anecdotal clues from industries suffering from structural problems. They will look instead for corporate leaders with wide-ranging activities that are cyclical in nature, which brings me to an article Mark Thoma flagged from yesterday’s New York Times, “ Have Recessions Absolutely, Positively Become Less Painful.” Mark takes issue with the sense of overconfidence regarding management of business cycles, a point I agree with. But my attention was draw to the following section:

No company embodies this change, for better and worse, quite like FedEx. When Alan Greenspan, the Federal Reserve chairman, sees Frederick W. Smith, FedEx's chief executive, during halftime of Washington Redskins games, Mr. Greenspan uses the company's vast reach to check in on the economy.

"He always asks, 'We still O.K.?' " said Mr. Smith, a part-owner of the team whose stadium suite abuts the one Mr. Greenspan uses.

More formally, Federal Reserve staff members rely on FedEx and the nearly six million packages it delivers every day for real-time data that helps set interest rate policy.

If this is so, then Greenspan can’t be happy with what he is hearing, especially with FedEx announcing a 5.5% increase in shipping rates  (WSJ subscription), the highest increase in at least nine years. FedEx is clearly confident enough about the outlook to pass on rising fuel costs to consumers. And it’s not just FedEx that’s raising prices – the Wall Street Journal reported that railroad customers are expecting a 5.6% rate hike in the next six months. It is also widely expected that UPS will join the party as well. These are the kinds of price increases that feed their way into virtually every business in the country. The Fed will worry that other firms in other industries will decide that they too should pass on higher costs to customers. Worry enough that they will want to nip it in the bud.

As a side note, notice that FedEx CEO Smith revealed Greenspan’s conversations to a reporter, just a few weeks after French Finance Minister Breton did the same. And the New York Times writes a story on the importance of FedEx to Fed staffers just a few days after FedEx announces a large price hike? Probably just coincidences, all of them – but I don’t like it when the coincidences start to pile up.

In short, worries about demand will not resonate with Fed officials who see enough goods being shipped around the country that freight companies can push through higher prices. In fact, these are the kinds of stories that leave a central banker sleepless at night, because, as Fisher so clearly stated, “any central banker worth his or her salt is genetically unable to tolerate inflation.” The Fedspeak suggests that other officials agree, loudly and clearly, on this point.

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