Fed Watch: Fedspeak Points To June

Tim Duy:

Fedspeak Points To June, by Tim Duy: Federal Reserve speakers were out and about today. First off, Richmond Federal Reserve President Jeffrey Lacker set a fairly high bar for NOT hiking in June. Via the Wall Street Journal:

“At this point, raising rates in June looks like the attractive option for me,” Mr. Lacker told reporters following a speech Tuesday in Raleigh, N.C. “Data between now and then may change my mind, but it would have to be surprising data.”...

...“The economy’s clearly growing at a more rapid, sustained pace than it was a year ago,” he said. “Economies that are growing faster need higher real interest rates, and a variety of indicators point to the need for higher real rates.”

What about inflation? It is all about oil:

Mr. Lacker said the effects of lower gasoline prices on inflation should be transitory, and he expects inflation will move back toward the Fed’s 2% annual target over the next year or two. “The inflation rate was clearly moving towards 2% before oil prices began falling last summer,” he said.

Here I worry, because Lacker is clearly ignoring the data, or least weighing the year-over-year changes far too heavily. Inflation actually accelerated in the second half of 2013, but was clearly decelerating by the beginning of 2014 (right idea, wrong dates) first half of 2014, but was clearly decelerating by June, prior to the oil shock. By July, the 3-month annualized change in core was just 0.97% while oil was still above $100 and gas above $3.50:

But the Fed is close to achieving the employment mandate, so inflation data be damned! Still think the employment part of the dual mandate is really a good idea?

San Francisco Federal Reserve President John Williams digs in his heals and assures us a rate hike is coming. Via the Financial Times:

John Williams, president of the Federal Reserve Bank of San Francisco, said the time for the US central bank to start raising rates is getting “closer and closer” amid faster-than-expected wage rises in January and “really strong” hiring. Some investors may be caught out by a rate increase, but that should not stop the Fed from tightening policy if necessary, he said.

What about inflation? No problem, it is all about the lags:

...Economists including Lawrence Summers, a former US Treasury secretary, have urged the Fed to leave rates unchanged until there is clear evidence that inflation, and inflation expectations, are set to breach its 2 per cent target.

However Mr Williams dismissed such calls, warning of the risk that the Fed gets behind the curve on inflation and that it could end up being forced to hike rates “much more dramatically” to rein in inflation, provoking market turmoil. Given the trails with which monetary policy operates it was better to start raising interest rates “gradually, thoughtfully”, he said.

Note that he pulled out the "if we don't hike now we will need to hike more later" argument. That, along with the financial stability argument, is how they will justify a rate increase in the absence of inflation. Williams, however, hedges on June:

A key question obsessing financial markets is whether the Fed pulls the trigger in the middle of the year or waits longer. Mr Williams did not commit himself to voting for a move in June, saying instead that the decision of whether to hike or delay a bit longer would be “in play” at that point.

Time is growing short for the wage gains necessary to begin hiking in June.

Importantly, Williams also rejects the idea that bond markets are signaling secular stagnation:

He dismissed arguments that low long-term bond yields in the US reflect fears of a gloomy outlook for the American economy, saying they more likely were a result of global financial conditions, amid slowdowns and policy easing in large parts of the rest of the world.

US policy would still be very accommodative even after the Fed raised rates, he stressed. “That first step of raising interest rates is just removing a sliver of that accommodation,” he said.

The last paragraph is key. Williams, like the rest of the FOMC argues that conditions will remain very accommodative after even a small rate hike. As I noted last night, this is not true under the secular stagnation hypothesis:

It would be interesting if we had William's estimate of the equilibrium rate for comparison. Wait, we do - from his January 2014 Brookings paper:

Oh my, that brownish-greenish line appears to be a fairly pessimistic estimate of the natural rate, certainly one inconsistent the assertion that conditions remain accommodative after even just a small rate hike. Perhaps some journalists should start pressing Williams on the policy implications of his research. And, for that matter, I think the Fed's view on the equilibrium real rate should be a front-and-center topic for the next FOMC press conference.

Meanwhile, soon-to-retire Dallas Federal Reserve President Richard Fisher is pegging his rate outlook to wage gains:

“If we were to see employment continue to increase, we’re getting much, much better on that front and you begin to see the wage price pressures, that should govern what we do with interest rates.”

The Fed simply has no justification to raise rates in June absent acceleration in wage growth. Even Fisher agrees. Fisher also pushes back against the renewed "Audit the Fed" movement:

“We are — I’ll be blunt — we are audited out the wazoo. Every Federal Reserve Bank has a private auditor. We have our auditor of the system. We have our own inspector general. We are audited. That’s not what he’s talking about. What he’s talking about is politicizing monetary policy.”

That's the plain truth. It has nothing to do with economics, and everything to do with politics.

Bottom Line: The Fed wants to hike in June. They continue to dismiss the inflation data, but they still need wage growth to hike. They dismiss the secular stagnation hypothesis. I hope they are right on that, or this is going to get ugly. Quickly.