Tim Duy's Fed Watch

Underappreciated Data

I must admit that I surprised by the tepid response to the advance release of the 4q2010 GDP data.  Mark Thoma catalogues the most common critiques – the negative contribution from government spending and the minimal reduction in the output gap.  My review of the data differs.  In my opinion, this is the first GDP report since the recession “ended” that offers a certain optimism, a glimmer of hope that perhaps that light at the end of the tunnel is not simply an oncoming train.  If it is an oncoming train, it not the train of sagging government spending, but instead a train of imports blasting forward.

It is no secret that this recovery, to date, has been anything but vigorous.  Certainly nothing like the “Morning in America” of the mid-80’s.  Real final sales – GDP excluding inventory effects – outperformed for quarter after quarter during that period as demand clearly outstrip the pace of capacity growth.  In comparison, real final sales during the most recent recovery has been almost laughable:

 

But real final sales surged in the final quarter of 2010:

A 7.1 percent gain is nothing to sneeze at – and, realistically, in the scope of that kind of surge in final demand, the 0.11 percentage point reduction from the government sector is little more than a rounding error (I would be more worried about the loss of services than the contractionary impact in the context of 7.1 percent final demand growth). This is exactly the kind of final demand growth needed to lift us out of this morass.

But is it sustainable?  What is apparent from this report is the potential for external support to generate real improvement in the US economy.  The sharp drop in imports meant that firms were forced to sharply reduce the pace of inventory growth.  Will those inventories be replenished with domestic or foreign production?  James Hamilton is not optimistic:

But the fact that a huge negative contribution of inventories coincided with a huge positive contribution of imports does not seem to be a coincidence. There's a clear pattern in the recent data that when one of these makes a positive contribution to GDP growth, the other makes an offsetting negative contribution. Although we often think of inventories as a substitute for production (you could either produce a good or sell it out of inventories), in the current environment inventories seem to act more as a substitute for imports (you could either import the good, or sell it out of inventories). So although inventories shouldn't be the same drag on GDP in 2011, I expect imports to go back up and exert a drag of their own.

Sadly, the story of this recovery continues to circle around the external accounts.  Absent a resolution of the global rebalancing story, faith in fiscal stimulus is somewhat misplaced – much government spending will simply leak abroad as evident in previous GDP reports.  Of course, the alternative, fiscal policy that ignores the recession, is not exactly an endearing policy course.  If rebalancing continues to be delayed in the months ahead, US policymakers simply must accept the trade deficit will reduce the effectiveness of their efforts.

Moreover, the resistance to rebalancing is nothing less than sadly ironic, as rebalancing produces the only possible win-win scenario in the global economy.  Consider that concerns of emerging market inflation suggest that demand is surging ahead of capacity, while deflation in the US suggests the opposite, excess capacity.  It seems that these problems are two sides of the same coin, with an obvious optimal solution – greater currency flexibility.  Emerging markets could satisfy higher rates of domestic demand growth via declining net exports, while rising net exports allows for higher capacity utilization in the US.  In effect, global consumption power would be redirected toward relatively poor economies and away from a relatively rich economy.  It seems quite reasonable.

Alas, instead we are faced with the challenges of rising inflation in some nations, and increasingly disturbing hoarding behavior in others.  While stories of a massive stock of empty housing in China have long circulated, the Wall Street Journal reports that the hoarding has reached a new level:

The amount of cotton held in hamlets throughout China is unknown, but, with 25 million cotton farmers, a Chinese cotton agency estimates it could amount to about 9% of the world's cotton supply. And the situation is occurring throughout the supply chain. Many ginners and merchants in China are keeping warehouses full, according to the agency, in an attempt to obtain higher prices.

Expectations that prices will rise are driving the apparent stockpiling, which causes short-term shortages and leads prices to rise further. The situation is complicating an already volatile picture for cotton, which has jumped to 140-year highs in the U.S. and has become a symbol of brewing commodity inflation around the globe.

Included in the story is a picture of a farmer storing 7,700 pounds of cotton in his home (I suspect my wife would object should I start taking a long position in hog bellies via physical possession in the living room).  To be sure, such behavior, like stockpiling empty houses, makes sense in an inflationary environment in which agents are desperate to find adequate stores of value.

Regarding other data, last week we also saw the December durable goods report.  While there was some concern over the headline numbers, it is generally safer to go straight to the core figures, capital goods excluding defense and air:

Looks like the economy shook off the summer slowdown, putting order back on the uptrend.  Somewhat disappointing was the partial reversal of recent improvement in initial unemployment claims.  That said, looking at the four-week moving average, the downtrend looks intact:

 

Of course, if final demand is growing at a 7.1 percent pace, the overall improvement in the final months of 2010 should come as no surprise.  Finally, also not surprisingly, the Case-Shiller Index reported ongoing home price weakness.  Housing has offered almost nothing to the recovery and, quite frankly, is yesterday’s story.   Housing is returning to its appropriate place in the economy – a product that provides a service, not an investment or, worse yet, a gamble.

Bottom Line:  The GDP report revealed what could be, the glimmers of hope of a V-shaped recovery.  If final demand even near the 4q2010 could be maintained, Federal Reserve policymakers makers would be forced to take notice by mid-year.  Still, setting aside the usual risk factors (including the fresh possibility that Mideast unrest triggers a fresh oil shock) the sustainability of this final demand is directly dependent upon the evolution of the external accounts.  If this demand surge is satisfied with an import surge in coming quarters, we can expect the recovery will remain tepid in comparison to previous deep recessions.  If rebalancing were to maintain some traction, this could be simply the first in a long-waited string of data that would proved a clear exit to the current period of relative economic stagnation.

Quick FOMC Response

The FOMC statement was largely as expected – sticking to the current policy path.  That means maintaining the current asset purchase program while holding interest rates low for an extended period.  Some specifics:

No Dissents:  Kansas City Fed President Thomas Hoenig is no longer a voting member, and none of the new voting members took up his dissent.  Completely unsurprising.  While some policymakers such as Philadelphia Fed President Charles Plosser believe that QE2 was a mistake, they see the costs –market disruption and loss of credibility – of undoing that mistake as greater than the benefits.

Additional Flexibility:  Note the change in the first sentence.  From:

Information received since the Federal Open Market Committee met in November confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.

To:

Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions.

A focus on a specific data point – unemployment – was replaced with the more general “labor market conditions.”  This could signal a willingness to roll back the balance sheet expansion if nonfarm payrolls were growing rapidly but, as workers return to the labor force, unemployment rates remain persistently high.  I have difficulty seeing the Fed raise rates as long as unemployment is high, but a return to allowing the balance sheet to contract naturally or directly would not be out of the question. 

Commodity Prices:  As expected, the FOMC is not poised to follow the path of ECB Head Jean-Claude Trichet and fret about headline inflation.  In contrast, the FOMC will focus on the pass-through to core inflation, if any, and the path of longer term inflation expectations.

Bottom Line:  No real surprises in this FOMC statement, with the exception of a slight change in language on labor markets that suggests an effort to create additional flexibility.

The “Recalculating” Debate

The fundamental nature of the recession continues to be debated – a debate with important policy consequences.  Is the recession the consequence of a general aggregate demand deficiency, or is it a structural consequence of the housing bubble?  If the former, the policy approach should be to support aggregate demand via a combination of fiscal and monetary policy.  If the latter, only time will resolve the challenge, and aggressive policy will only lead to inflation. 

David Beckworth and Ryan Avent provide nice summaries of the nature of the debate.  Paul Krugman argues that the answer is obviously a demand shortfall, and bemoans:

Now, however, we’re seeing a much more widespread attack on demand-side economics. More than that, it’s becoming clear that many people don’t so much disagree with the idea that demand matters as find it abhorrent, incomprehensible, or both.

Nick Rowe offers an alternative explanation:

For decades my job has been to teach students that, despite the evidence of their senses, and contrary to their hearsay of the heretical teachings of the Keynesian Cross, aggregate output is basically supply-determined. Which it is. Basically. Though short-run fluctuations in demand can and will cause short run fluctuations in aggregate output around an average level that is determined by the supply-side.

And, for once, the memories of their parents are actually supporting me in my job. Look what happened in the 1970's, when demand increased. Printing too much money and increasing demand really did cause inflation. It really didn't make us all richer. It didn't reduce unemployment.

Now, just for once, we have to switch gears. These times are not normal. Just for once, the demand side really is the problem. Just for once, the overly obvious truth your senses are telling you really is the truth. Just for once, your parents' experience of the 1970's doesn't apply. Just for once, it really is OK to have a drink, even though you are a recovering alcoholic.

In some sense, economists diluted the reasoning of demand side macroeconomics with a focus on supply side factors.  The Great Moderation only served to entrench the supply side view – after all, by the late-90’s I recall articles suggesting that we had conquered the business cycle.  Demand side fluctuations had become a thing of the past.

I would offer another observation.  I agree that the issue is a shortfall in demand.  And not just for this recession, but arguably the entire last decade. That said, I think it is easy to lose sight of this demand shortfall in light of another feature of the past two business cycles.  Both appear to have been inexorably connected to asset price bubbles, first in information technology and then in housing:

 

Supporting sufficient aggregate demand to maintain full employment looks to have required supporting relative levels of net worth well above a decades-long baseline.  And pushing net worth to those levels was a consequence of asset price bubbles.  Hence, it appears that the demand generated by that wealth was “fake.”  Moreover, that “fake” demand arguably induced a supply side effect by pushing capital first into information technology and then into housing.  To be sure, ultimately the impacts of such capital misallocations will fade away.  Information technology depreciated rapidly, and the excess housing stock will eventually be absorbed by a growing population.  It is not quite obvious, however, why this adjustment needs to extend to such a large portion of the workforce.  The answer, I think, is not the housing adjustment itself, but the loss of general demand precipitated by the housing decline and subsequent balance sheet malaise.

The wealth-supported demand surely was not “fake,” as real goods and services were indeed purchased.  But it was ephemeral, evaporating with the popping of bubbles.  So it should be of little surprise the Federal Reserve is viewed by some as doing nothing more than supporting another round of “fake” demand.  Fed officials probably compound this problem by citing the stock market increase as evidence that QE2 is working.  Via the Wall Street Journal:

In recent weeks, the Federal Reserve has been turning to an unusual metric to prove the potency of its bond-buying program: the stock market.

Comments from Fed Chairman Ben Bernanke and other officials, as well as research by the central bank, cite rising stock prices as a sign that the central bank’s $600 billion bond-buying program is working to bolster the economy.

Of course, it is perfectly reasonable for officials to note that high equity prices signal improving economic prospects, the latter a consequence of their policy stance.  Some, however, may interpret this as further evidence that the Fed is simply trying to create another asset price bubble, which will, if history is any guide, will also prove to be fleeting.  The resulting aggregate demand will then be viewed as “fake.”  In this light, the Federal Reserve is not really fixing anything, just papering over the underlying problem.

In short, I appreciate hesitation to embrace “more money” as a solution when it appears that “more money” was part of the problem.  Indeed, I used to be more sympathetic to that notion than I am now.  

But what exactly is the underlying problem?  Or is there an underlying problem?  I don’t know that we have agreement on that.  Why was the US economy dependent on asset bubbles to spur demand over the past decade, and will the same be true for the next decade?  Is the Fed’s current policy stance destined to fuel another bubble?  I don’t think that is a excuse to forego monetary and fiscal support – the alternative of ongoing high unemployment is not particularly enticing – but I think we would all feel a bit more comfortable if the next decade sees robust growth without an asset price bubble.

 

Inevitable Inflation Fears

The Wall Street Journal is reporting that ECB head Jean-Claude Trichet is turning increasingly hawkish:

Inflation fears—fueled by spiraling food, oil and raw material prices—are mounting around the globe, prompting the head of the European Central Bank to signal that it could raise interest rates in the future even though some countries have been weakened by the Continent's debt crisis.

In an interview with The Wall Street Journal ahead of this week's annual meeting of the World Economic Forum in Davos, Switzerland, Jean-Claude Trichet warned that inflation pressures in the euro zone must be watched closely, and urged central bankers everywhere to ensure that higher energy and food prices don't gain a foothold in the global economy…

An interesting development in light of the ongoing (or is it never ending?) European Debt Crisis.  Rate hikes will just be adding insult to injury for the peripheral nations already struggling with a debt-deflation spiral.  The price for being part of the Euro just keeps getting higher.

Inflation fears have yet to grip the Federal Reserve, for good reason.  Back to the Wall Street Journal:

While high unemployment and spare capacity are restraining underlying inflation pressures in the U.S. and elsewhere in the developed world, annual inflation in China is almost 5%—and a sizzling 9.8% economic growth rate in the fourth quarter triggered fears of more price pressures ahead. Inflation in Brazil is even higher.

The next inflation crisis is not occurring in the US, as opponents of QE2 thought likely, but in the developing markets instead. To be sure, my sympathy for developing nations wore thin long ago.  They will identify the Federal Reserve as the proximate cause of their problems, whereas they have only themselves to blame.  Higher inflation abroad was the only outcome if the protocols of Bretton Woods II did not submit to the onslaught of QE2.  And the Federal Reserve has very good reason to keep the pedal to the medal.  A review of recent inflation behavior:

If inflation abroad is a problem, it is not because the Federal Reserve has set rates too low, but because emerging markets been unwilling to allow their currencies to appreciate sufficiently against the Dollar.  See, for example, recent Dollar buying on the part of Brazil.  See also Paul Krugman, who illustrates the clear difference in emerging and developed nation industrial production trends.  Again, if inflation abroad is a problem, it is one that emerging markets need to tackle themselves.

Expect global tensions to continue building as emerging markets fight the Fed.  While the Fed may identify higher commodity prices as a potential concern, policymakers are not likely to reverse course and tighten policy unless higher commodity prices push through to core inflation.  Such an outcome appears unlikely given persistently high unemployment.  Consider too that the likely outcome of rising commodity prices is to slow US growth, thereby decreasing the odds of pass-through to core.

I have said this before – I do not see how this ends well.  Given that the Fed is not likely to back down from this fight, emerging markets need to put the brakes on their internal inflation issues, the sooner the better.   Otherwise they will be facing pain of a real inflation crisis, one that requires stepping on the brakes even harder.  How this story unfolds this year will determine of the global economy can transition to a sustainable, balanced growth trajectory, or plunges into yet another of the seemingly all-too-frequent crises.  

 

Housing and the Fed in 2005

The Federal Reserve released the 2005 FOMC transcripts this week.  Attention quickly turned to the Fed's view of the growing housing bubble.  Calculated Risk finds some very prescient warnings from then Atlanta Fed President Jack Guynn, who describes housing as an "accident waiting to happen."  Bloomberg continues with the obvious path of criticism:

Federal Reserve staff and policy makers identified a housing bubble in 2005 and failed to alter a predictable path of interest-rate increases to slow down the expansion of mortgage credit, transcripts from Open Market Committee meetings that year show.

Led by then-Chairman Alan Greenspan, the FOMC raised the benchmark lending rate in quarter-point increments to 4.25 percent from 2.25 percent at the end of December 2004. The committee also removed uncertainty about the pace of rate increases by telegraphing that future moves would be “measured” in every statement.

The “measured” pace language helped fuel the housing boom by keeping longer-term interest rates low and was inappropriate at the time given the uncertainties about both inflation and asset prices, said Marvin Goodfriend, a professor at Carnegie Mellon University in Pittsburgh.

“It was a major mistake of the Fed,” said Goodfriend, who attended some of the 2005 meetings as a policy adviser to the Richmond Fed. “It gave markets a sense that the Fed was on top of everything to a degree that wasn’t the case. It gave the impression that this was a mechanical adjustment to normality. The market was overconfident.”

David Beckworth follows up:

With the release of the 2005 FOMC transcripts we learn that the Fed was aware of the housing boom but failed to alter monetary policy.  Among other damning evidence, we find this gem in the December 2005 FOMC meeting.  It shows the real federal funds rate compared to the Fed's estimate of  the equilrium or neutral real federal funds.  There is a striking gap that emerges during the early-to-mid 2000s.  This indicates the Fed was highly accommodative and aware of it.

The problem with this criticism is that it fails to capture the implications of the low interest rate environment for the economy at large.  Andy Harless, in a response to Beckworth, beats me to the punch:

I just don't get how this Fed-too-easy story is consistent with the data on NGDP growth. From 2001 to 2006, NGDP grew at an annual rate of 5.3%. That's actually slightly slower than the prior 5 year period (5.4%) or the 5 years before that (also 5.4%). If the Fed was too easy in 2002-2003, then that period should have been followed by a huge boom in NGDP. It wasn't. All that happened was that NGDP grew (almost) fast enough (about 6% annually) to make up for the slow growth during the recession and the year of weak recovery that followed. As far as I can tell, the data vindicate the judgment of Fed officials who ignored the model-based estimates. 

Looking back at the path of nominal GDP over the last decade:

 
 
Considering the path of employment, output, and prices, I have difficulty arguing that the level of rates was significantly wrong.  I tend to think that regulatory failure was the primary Fed error - if the Fed realized the housing market was evolving into a bubble, shouldn't they have been more focused on the kind of mortgage lending that was taking place?  Shouldn't, in their jobs as banking regulators, made more aggressively us of stress tests before housing prices began to melt?  More directly, from a regulatory perspective, the Fed simply lost view of its societal function.  Via Rajiv Sethi:

But even in our very imperfect world, might we not have been able to stabilize output and employment by returning quickly and forcefully to the original mandate of the Federal Reserve, to channel credit preferentially to productive uses?

The Fed was probably too captured by a free markets ideology to seriously question the  wisdom of channeling so much capital into housing, which was really less about capital investment and more about consumption.  And, in their defense, attempting to direct capital flows is indeed tricky business fraught with peril.   But allowing everybody and their cousin to get a half million dollar mortgage with no income documentation?  Addressing that issue seems like it should have been doable.

Still, rather than lay all the blame at the feet of monetary policymakers, I think the real question we still need to resolve is more fundamental.  Turning the question around, why did the US economy struggle so dramatically this decade that the Fed was pushed into a very low interest rate environment?  The jobs record is simply unprecedented - a decade with no job growth.  To what extent are domestic policymakers to blame?   And was it domestic policy at all?  I don't recall the 1970's as a policy paradise, but at least jobs were created over that decade.  Answers will vary; mine is that US policymakers across the ideological spectrum allowed and even supported the pursuit of foreign nations' mercantilist policies on a unprecedented scale, thereby distorting global patterns of production and consumption in a way that fundamentally hobbled the US economy.  If this is true, how can we chart a path back?

In short, I think we need to understand why the last decade was jobless - it is tempting to blame the Fed, but the story is likely deeper.  Until we do, I don't think I can definitively say the next decade will be any different.

A Mixed Bag of Data

Tim Duy:

A Mixed Bag of Data, by Tim Duy: Today's data flow suggests ongoing expansion, but should also send a note of caution. Industrial activity continues to respond to firming demand, but capacity has yet to show solid gains. Firms are still not sufficiently confident, or lack sufficient demand, to justify widespread investment. Similarly, consumer spending continues along its upward trend, although the increase in energy costs are likely constraining the pace of that growth and keeping a lid on consumer confidence. Something of a mixed bag largely consistent with the general consensus view.

Start with the better than expected industrial production report, via Bloomberg:

Industrial production in the U.S. rose in December more than forecast, boosted by gains in business equipment and home electronics that indicate factories remain at the forefront of the recovery as the new year begins.

Output at factories, mines and utilities climbed 0.8 percent, the most in five months, after a revised 0.3 percent increase in November, figures from the Federal Reserve showed today in Washington. Economists forecast a 0.5 percent gain, according to the median of 82 projections in a Bloomberg News survey. Manufacturing climbed 0.4 percent, and utility output increased 4.3 percent as snowstorms swept parts of the nation.

I have taken to looking at the capacity data for signs of a solid, self-sustaining recovery. Here we see the most tentative signs of improvement, or at least stabilization:

Looking back at the decade, capacity gains really took hold in late-2004 as the economy finally shook off the post tech-bubble doldrums on the back of the building housing bubble:

Before one gets too excited at the possibility, we can take a look back at the pace of progress during the 1990s.

We should be hoping for a recovery more like the 1990s than the 2000s, but it is challenging to find a story that allows for that kind of growth. I am not even sure how we get the recovery of the 2000s without an asset price bubble.

Moving on to retail sales, the numbers fell short of the outsized expectations that developed in the run up to the Christmas season. Still, the overall trend looks intact:

That said, I think you get a cleaner picture of underlying consumer trends by stripping out auto related sales:

Here the rebound looks less impressive, but the trend remains in the right direction. That said, there was a noticeable decline in the rate of monthly growth during the final quarter, 0.77%, 0.59%, and 0.36% for October, November, and December, respectively. I think it is safe to say that the consumer has some momentum, especially with rising nonfarm payrolls, but higher energy prices are likely to constrain the pace of growth going forward.

Similarly, rising energy costs were a culprit behind the decline in consumer confidence. And those higher costs clearly showed up in the consumer price index. Bloomberg has a curious introduction:

The cost of living in the U.S. climbed more than forecast in December, led by higher fuel and food prices, while other goods and services showed the smallest annual increase on record.

Looking at the the CPI release, one gets something of a different story:

The energy index increased in December. The gasoline index rose sharply and accounted for about 80 percent of the all items seasonally adjusted increase. The household energy index, which declined in November, increased as well. The food index increased slightly in December, with the fruits and vegetables index rising notably.

The headline increase was driven by energy, not food as Bloomberg reports. Core prices increased just 0.1% for the month and 0.8% compared to last year. So far, higher energy/commodity prices have yet to work their way through to final prices, not surprising given persistently weak labor markets and consistent with the Beige Book story.

Finally, Richmond Fed President Jeffrey Lacker offered up the possibility of reviewing the large scale asset purchases:

“While the outlook may not have improved enough yet to warrant adjusting our purchase plans in the near-term, I anticipate earnest re-evaluation as economic developments unfold in the months ahead,” Lacker said today in prepared remarks of a speech in Richmond, Virginia.

I am not surprised that some policymakers would point to better data as a reason to reevaluate the program. But I would think about the timeline on this. Lacker says describes the process in the months ahead. But how many months do we have left? The current program is expected to end by the second quarter of this year, just about 5 months. Unless growth explodes, by the time FOMC members would feel comfortable disrupting the plan, it will be almost complete anyway. Even other traditionally hawkish policymakers expect the plan to concluded as planned.

Bottom Line: Data generally in line with a sustainable growth, but expectations that the economy is about to take off remain premature. Inflation fears still appear overblown given that inability to pass higher commodity prices through to consumers. Energy prices, however, do appear to be constraining consumer spending. Overall better data will continue to be reflected in Fedspeak, but time is running short to change the current asset purchase program.

Shifting to Autopilot

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.

Are Oil Prices About to Undermine the Recovery?

Calculated Risk directs us to an LA Times story identifying the possibility that rising gasoline prices will undermine the recovery. He also reminds us that James Hamilton recently wrote on the subject as well, concluding:

I could certainly imagine that an abrupt move up in gasoline prices from here could hurt the struggling recovery of the domestic auto sector and dampen overall consumer spending. I do not think it would be enough to give us a second economic downturn, but it could easily be a factor reducing the growth rate.

I would add that the current price appears inline with the general upward trend since the beginning of last decade.  Here I extrapolated on the 2000-2006 trend:

 
The sudden rise in oil in 2007, a clear deviation from the trend in the first half of the decade, led to substantial demand destruction, a severe blow to the US economy which at the time was struggling under the weight of the housing meltdown and the financial crisis (and arguably still is).  The recent rise in oil appears different, more a reestablishment of the previous trend. 

From this point on, I tend to think the issue is less of will oil continue to rise, but at what speed will it rise.  The trend over the last decade appears to make a lie of recent claims that we have entered into a period of plentiful energy (see also James Hamilton), and while higher oil prices will tend to crimp growth, a gradual price increase should allow for non-disruptive adaptation on the part of economic agents.

What I more concerned with is the possibility of another sharp spike in prices, such as occurred in 2007-08.  A repeat of that incident would once again cripple households, who, after 18 months of recovery, are just barely starting to see the light.  The most obvious channel to trigger such a spike is monetary, that the Federal Reserve's large scale asset purchases trigger a disruptive decline in the Dollar.  Federal Reserve Chairman Ben Bernanke was not buying that story last week.  From the Wall Street Journal:

Mr. Bernanke says his quantitative easing policy is not to blame for the sharp increase in the price of oil. Instead, oil’s rise is the result of strong demand from emerging markets. The dollar, he notes, has been “quite stable” in the past few months. One worry in the run up to the Fed’s $600 billion bond-buying announcement in November was that it was going to cause the dollar to fall sharply, which would in turn put upward pressure on commodities like oil priced in dollars. The stable dollar, which has risen since the program’s announcement, implies the Fed isn’t the problem in commodities markets, Mr. Bernanke notes.

Movements in commodity prices have not been sufficiently disruptive to suggest a Fed-induced cause is at hand, and have tended to be more consistent with indications of general economic improvement.

In short:  Energy prices are yet another thing to keep an eye on.  Still, recognize the increase to date appears to be more of a return to the recent trends than a disruptive price spike.  Not that rising prices won't have consequences, but the trend of the past decade may simply be something we need to learn to live with.  Rather than watching the trend itself, be watching for upward spikes from that trend - those would almost certainly translate into something nasty for the still struggling US economy.

More of the Same

The jobs report was a clear disappointment relative to both expectations at the beginning of the week and certainly after the blowout ADP report.  After adjusting expectations to the upside, ADP once again scores a major miss (how we came to care about this data series still remains a mystery to me).  That said, the overall tenor of fourth quarter employment reports suggest an economy growing around trend growth.  Better, but not good enough to prompt a policy response from the Fed.

 The headline NFP gain was 103k overall, 113k private.  Consensus had been looking for something around 140k at the beginning of the week.  On the upside, the BLS revised up the October and November numbers, so that the average monthly NFP gain during the fourth quarter was 128k, pretty much right in the middle of the 100k to 150k estimates of growth required to keep a lid on unemployment.  And the unemployment rate did more than hold steady - it retreated, falling from 9.8% to 9.4%.  The improvement, however, is less positive than at first blush.  Persistently high unemployment continues to drive workers out of the labor force, illustrated by a fresh decline in the labor force participation rate:

 
The report internals were not particularly reassuring if one is still looking for the fabled V-shaped recovery.  Gains in wholesale and retail trade as well as transportation and warehousing   were consistent with the generally solid consumer spending news during the quarter.  But the biggest gainer was the ever consistent health care sector, which added 37.1k.  Something of a disappointment was the deteriorating trend in the rate of temporary help gains - the sector added just 15.9k jobs, down from 31.1k in November and  28.6 in October.  Weekly hours, both average and aggregate were unchanged, while hourly wage gains were a minimal 3 cents.

In short, nothing to change the direction of monetary policy, a point reinforced by Federal Reserve Chairman Ben Bernanke's Senate testimony today.  Although Bernanke begins with a nod to the recent data:

More recently, however, we have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold. In particular, real consumer spending rose at an annual rate of 2-1/2 percent in the third quarter of 2010, and the available indicators suggest that it likely expanded at a somewhat faster pace in the fourth quarter. Business investment in new equipment and software has grown robustly in recent quarters, albeit from a fairly low level, as firms replaced aging equipment and made investments that had been delayed during the downturn.

his ultimate conclusion remains unchanged:

Although it is likely that economic growth will pick up this year and that the unemployment rate will decline somewhat, progress toward the Federal Reserve's statutory objectives of maximum employment and stable prices is expected to remain slow. The projections submitted by Federal Open Market Committee (FOMC) participants in November showed that, notwithstanding forecasts of increased growth in 2011 and 2012, most participants expected the unemployment rate to be close to 8 percent two years from now. At this rate of improvement, it could take four to five more years for the job market to normalize fully.

Bernanke continued his defense of large scale asset purchases, explaining the importance of ongoing monetary easing given the persistent deviation of unemployment and inflation from the Fed's mandate.  He also emphasizes that this policy is ultimately temporary and not equivalent to unbounded government spending:

As I am appearing before the Budget Committee, it is worth emphasizing that the Fed's purchases of longer-term securities are not comparable to ordinary government spending. In executing these transactions, the Federal Reserve acquires financial assets, not goods and services. Ultimately, at the appropriate time, the Federal Reserve will normalize its balance sheet by selling these assets back into the market or by allowing them to mature.

Bernanke then places himself, again, in the middle of the fiscal policy debate.  Should this be the purview of the Fed Chair?  Does it invite Congress to meddle with monetary policy?  Is this a reflection of Bernanke's political affiliation, his desire to take sides with fellow deficit hawk Republican's?  Interesting that Bernanke continues the tradition of blaming retirees for the nation's fiscal challenges:

In subsequent years, the budget outlook is projected to deteriorate even more rapidly, as the aging of the population and continued growth in health spending boost federal outlays on entitlement programs. Under this scenario, federal debt held by the public is projected to reach 185 percent of the GDP by 2035, up from about 60 percent at the end of fiscal year 2010. 

By linking the aging population and health care costs in the same sentence, he sends the message that the old are sick and consequently the cause of the impending crisis.  I would have preferred that he explicitly separated rising health care prices we all face from the issue of the aging population. 

Bottom Line:   The employment report was lackluster, consistent with expectations the US economy is operating - sustainably - around trend growth.  The report was also consistent with the view that this just isn't good enough to rapidly alleviate the hardships imposed by the recession.  The lack of more dramatic improvement in labor markets keeps the idea of policy tightening off the FOMC's table, and while I can envision the Fed bringing a halt to large scale asset purchases when the current program is complete, given the employment and inflation data, I can't wrap my mind around a rate increase this year.

Time To Cut The Cord

I see that Comcast just raised cable prices.  I find it remarkable that cable companies apparently can not see the train wreck ahead.  I figure that I can drop the cable and the phone (who uses a landline anymore?), ugrade to a faster internet connection and still come out ahead nearly $100 a month.

$100 a month will buy more AppleTV rentals than I can watch, especially given the vast amount of free content not available.  Pay a dollar, rent a show commerical free, or watch online for free with limited commerical interruptions.  Skip the middle men of the cable companies. How long do the cable companies think they can last charging people for dozens of channels they never watch?  I don't see how that model survives.

The one challenge I know I will face is sports programming.  But I think I can find plenty of places in town to watch the Ducks play and socialize at the same time. 

Anyone else cutting the cord?  Happy with the decision?