Shifting to Autopilot, by Tim Duy: Incoming data this week suggest the US economy continues to meander on its upward path, albeit at a rate that is decisively lackluster, at least relative to the magnitude of the output gap. That path of growth guarantees the Fed completes the current large scale asset purchase program. But soon we will have to turn our attention to what comes next. The baseline scenario is that the Fed holds pat - holding the balance sheet steady for the remainder of 2011, a scenario endorsed by at least two policymakers this week. Still, we should continue to challenge this assumption. Considering the expected slow improvement in labor markets and tame inflation, will the Fed consider extending asset purchases beyond the most recent $600 billion? Probably not.
Thursday we saw some reminders that the path to recovery is not a straight line. First, initial unemployment claims retraced some of the recent declines. Mark Thoma has the story here. To be sure, given the noise in this series, one week of data contains limited information. In general, the downward trend remains intact. Still, it argues against expectations the job market is set to rocket forward.
Housing news continues to tell the same old story. The record level of foreclosures in 2010 is not expected to be a record for long, while more evidence collects that housing prices are still falling. That said, housing is an old story. Nothing to see here folks, please move along.
More importantly, the trade data also was not as supportive as one could hope. While the nominal deficit improved in November, the real deficit deteriorated slightly in contrast to October's significant improvement. Still, barring a surprise deterioration in December, the external accounts should contribute positively to 4Q10 growth. To be sure, this adds to the positive momentum heading into 2011, but one quarter is not enough to break the general downward trend of 2010. The combination of high unemployment and a lack of clear direction on rebalancing of global activity promises to keep the threat of global trade wars alive. US Treasury Secretary Timothy Geithner rattled the sabers this week to keep pressure on his Chinese counterparts. From the Wall Street Journal:
"We are willing to make progress" on issues of interest to China, Mr. Geithner said at Johns Hopkins University's School for Advanced International Studies, "but our ability to move on these issues will depend on how much progress we see from China," including a faster appreciation of the Chinese currency.
To be sure, I question whether Geithner is truly committed to global rebalancing. A reminder from Bloomberg:
U.S. Treasury Secretary Timothy F. Geithner said he has continued to support the strong dollar policy he helped craft in the Clinton administration when he worked for his predecessor Robert Rubin.
“That particular phrase and commitment of policy was first written in my office at the Treasury Department in 1995,” Geithner said today, when asked about the currency during a Senate Finance Committee hearing.
Sorry, don't mean to be skeptical, but I am sensing mixed messages. The resolution, of course, is that the appropriate policy direction is one of managed exchange rate depreciation - no sudden stops of capital, please. On this point, Geithner talks a good game:
Geithner said he agreed that the U.S. needs to show commitment to lowering its deficits over time, to avoid losing the confidence of investors around the world. That could hurt the economy, raise interest rates and reduce investment, the Treasury chief said.
“If we do not make people believe that we are going to fix those deficits, bring them down over time, then we will risk losing confidence in our financial future,” Geithner said.
Something of a Catch-22, I fear. Sustaining confidence in US markets means resolving long term US fiscal issues, but there is no pressing reason to address those issues in the absence of a loss of confidence.
Ultimately, I fear that should the Dollar fall enough to provide a significant boost to the US economy, it will also be enough to rattle Wall Street. I hate to say it, but I suspect should that point be reached, Washington will choose Wall Street over Main Street. Pessimist or realist? Of course, the ongoing European crisis suggests this is not a problem anything soon, as the uncertainty helps prop up the Dollar. I imagine US policymakers are in an uncomfortable place (or at least should be) on that topic. They probably want to see the Euro remain intact, rather than risk the impact of a rapidly appreciating Dollar. Of course, that means forcing a debt-deflation spiral on the periphery nations. Doesn't seem quite right.
Warts aside, forecasters continue to upgrade their expectations for US growth. From the Wall Street Journal:
Economists have steadily grown more upbeat about growth in recent months and boosted their estimates for the fourth quarter of 2010 in this survey. On average, respondents now estimate the U.S. grew 3.3% at a seasonally adjusted annual rate in the fourth quarter—up from an estimate last month of 2.6% growth. The economy grew 2.6% in the third quarter.
Amid the stronger growth forecasts, economists now expect the U.S. to generate nearly 180,000 jobs a month on average this year, significantly more than last year's average of 94,000. But with continued population growth, that isn't nearly enough to quickly bring down the unemployment rate, now at 9.4%. By the end of 2011, the economists, on average, expect the jobless rate to be 8.8%.
Federal Reserve Chairman Ben Bernanke shares a similar view:
“We see the economy strengthening,” Bernanke said as part of a panel discussion on boosting lending to small businesses. “It looks better in the last few months. We think that a 3 to 4 percent-type of growth number for 2011 seems reasonable.”
“Now you’re not going to reduce unemployment at the pace that we’d like it to,” Bernanke said. “But certainly it would be good to see the economy growing. That means more sales, more business for companies of all sizes.”
So, let's establish 3 to 4% as the Bernanke Baseline, which would be above trend growth, but, as Bernanke reiterates, still imply painfully slow improvements in the unemployment rate. Still, above trend it is, and that suggests to me that extending the current asset purchase program would meet a great deal of internal resistance. True to form, Dallas Federal Reserve President Richard Fischer, now a voting member of the FOMC, appears opposed to additional action:
The entire FOMC knows the history and the ruinous fate that is meted out to countries whose central banks take to regularly monetizing government debt. Barring some unexpected shock to the economy or financial system, I think we have reached our limit. I would be wary of further expanding our balance sheet. But here is the essential fact I want to emphasize today: The Fed could not monetize the debt if the debt were not being created by Congress in the first place...
...the key to correcting the underperformance of the American economy and American job creation does not rest with the Federal Reserve. It is in the hands of those who make fiscal and regulatory policy.
The Fed has reduced the cost of business borrowing to the lowest levels in decades. It has seen to it that liquidity is widely available to banks and businesses. It has kept the economy from deflating and it has kept inflation under control. This has helped raise the economic tide. Recent data make clear that the risks of a double-dip recession and deflation have ebbed and that economic growth and job creation are beginning to flow…
I don’t believe this has much to do with the Fed. None of my business contacts, large or small, publicly held or private, are complaining about the cost of borrowing, the lack of liquidity or the availability of capital. All express concern about taxes, regulatory burdens and the lack of understanding in Washington of what incentivizes private-sector job creation. All are stymied by a Congress and an executive branch that have appeared to them to be unaware of, if not outright opposed to, what fires the entrepreneurial spirit. Many have begun to feel that opportunities for earning a better and more secure return on investment are larger elsewhere than here at home.
Colorful, as always. I have to admit enjoying Fischer's speeches, at least for their entertainment value. Still, he is not immediately worried about inflation:
The policy maker said he saw some evidence that firms are trying to push through price increases, and added commodity prices are on the rise mostly on strong global demand factors. But he also allowed that the Fed’s easy money policy may be contributing to some of the gains. That said, Fisher is not worried about inflation, saying “I don’t see inflation presently” or in the “immediately foreseeable future.” Instead, policy makers’ problem “is getting the economy moving again.”
No time to halt current policy. This repeats the story of the Beige Book:
Most District reports mentioned increasing prevalence of cost pressures but only modest pass-through into final prices because of competitive pressures.
Pushing through hirer prices remains a challenge. Another FOMC member who spoke up on the asset purchase program was now voting member Philadelphia Fed President Charles Plosser:
Charles Plosser, president of the Federal Reserve Bank of Philadelphia, was the latest to signal a desire for continuity from the Fed, even though he is highly skeptical of the program's effectiveness. "I wish we hadn't done it, but that doesn't mean I want to stop it right now," Mr. Plosser said in an interview with The Wall Street Journal...
...In a separate interview with The Wall Street Journal, Mr. Fisher said, "I would not have voted for QE2 had I been a voting member" last year.
Neither Fischer nor Plosser would be willing to call an end to the current program, but with growth above trend, both would likely dig in their heals against additional action. I don't think they would be alone. Remember, the Fed was hesitant to act further last summer, clinging to forecasts of solid growth. It was only the mid-year slowdown and its threat of a double-dip that pushed them into action. If Bernanke's current forecast is realized, it is difficult to see where the support would come from to prompt another round of easing.
Bottom Line: The data still is not perfectly clean. That said, forecasts for 2011 are firming, both within and outside the Fed, and pointing toward above trend growth. Nothing spectacular, to be sure, which will keep up the pressure on the Administration to address high unemployment. That promises continued verbal support of external rebalancing from Treasury. On the monetary front, Bernanke will have plenty of support to continue the current policy, but the FOMC will be wary about further easing. At the same time, the current constellation of growth, inflation, and unemployment rates argues against any tightening in the near term. Policy is thus likely to shift to autopilot.