Tim Duy's Fed Watch

FOMC Snoozefest

The Federal Reserve completed its July meeting with statement that pretty much everyone anticipated in advance. Interest rates were left unchanged and the Fed opened the door to begin balance sheet reduction "relatively soon." That means September. There was no reason to believe that the Fed does not still expect a third rate hike for this year which, if it comes, will be in December. That hike is of course data dependent.

A couple of quick notes. Regarding balance sheet reduction, I think this via Bloomberg is correct:

“September is the most likely outcome” for the launch of the balance-sheet drawdown, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “But I can’t rule out the idea that they would wait until November if the debt ceiling really looks messy.”

Clearly, the Fed will stand pat if certain policymakers in Congress and the White House (you know who you are) insist on sending the US economy down the path of debt default (I can't believe I even have to consider such insanity).

On inflation, some I think interpreted this as dovish:

On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

First, this is simply a factual statement, an acknowledgement of what everyone and their brother already knows. Second, what is important is the forecast, and that remains unchanged:

Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

And third, pay attention to the "12-month" language that first appeared in the May statement. Pay close attention. They Fed is telling us to stop paying attention to all those year-over-year inflation charts we like to make. They have accepted that level effects from inflation shortfalls in the first half of this year will live in the year-over-year numbers until next year. Pay attention to the path of the month-over-month numbers (blue bars):

If those numbers climb back up toward 2 percent this year, the Fed will feel vindicated even if the year-over-year numbers remain below target. Not just vindicated, but also inclined to raise rates as expected.

Bottom Line: Fed remains on its existing policy path. 

Easier Financial Conditions Will Keep the Fed on Track

The path laid out by the Federal Reserve at the beginning of the year for three interest-rate increases plus the start of reducing its $4.5 trillion balance sheet looks shaky due to the slowdown in inflation. There’s no question that the Fed is nervous about the persistent inflation shortfall. Chair Janet Yellen made note of the issue during her congressional testimony earlier this month.

Continued at Bloomberg Prophets...

This Expansion Will End in a Fizzle, Not a Bang

The Fed is growing increasingly concerned that this expansion will end like the last two, with a collapse in asset prices that brings down the economy. That concern will lead the central bank down the path of excessive tightening. Worse, that logic misses a key point. In both of the last two cycles, there was a sizable imbalance in the economy that extended beyond financial assets themselves. So far, the current environment lacks such an imbalance. That suggests the expansion ends with more of a fizzle than a bang.

Continued at Bloomberg Prophets...

June Employment Report Recap

A generally upbeat June 2017 employment report supports the Fed's case for additional monetary tightening, most likely in the form of balance sheet action in September followed up by a 25bp rate hike in December. Moreover, the solid pace of job growth will encourage the Fed to maintain 2018 policy projections as well. Although the unemployment rate ticked up, ongoing job growth at this pace will eventually push it back down. Weak wage growth continues to restrain the Fed from accelerating the pace of easing; the tepid pace of wage gains suggests the Fed's estimates of full employment remain too high.

Nonfarm payrolls rose by 22sk in June, above expectations. Moreover, both April and May were revised higher. The three month and twelve month paces are just below 200k. Job growth continues to slow, but the rate of decline is very shallow:

Looking into the future, temporary help payrolls continues to climb after the transitory slowdown in 2015:

This typically indicates sustained broad job growth in future months. Further evidence of a solid job market is visible in the accelerating of aggregate hours worked:

Payroll growth remains above the roughly 100k the Fed believes is necessary to hold the unemployment rate constant once demographic impacts outweigh cyclical impacts on labor force growth. For June, however, the unemployment rate ticked up on the back of higher labor force participation:

Still, the Fed won't take much relief in the gain. For all intents and purposes, labor force participation has been move sideways since 2014:

The monthly variance so far has been just noise.

Despite low unemployment, wage growth remains anemic:

One would have expected a pickup in wage growth if the economy were indeed operating substantially beyond full employment. This gives the Fed something to think about in the latter half of this year - they don't want to choke out growth too quickly if the natural rate of unemployment is in fact much lower than current estimates. Still, concern that wage growth will soon spike if their estimates are correct encourage most Fed policymakers to keep their foot gently on the brake. 

Bottom Line: Even as weak wage growth couples with soft inflation to raise a bit of caution among central bankers, the overall tenor of the labor markets remains sufficient for the Fed to maintain its tightening bias. They really need softer job numbers to thrown in the towel on their expected policy path for 2017 and 2018.

 

Employment Report Coming Up

The BLS will release the June employment report tomorrow. Wall Street is looking for an NFP gain of 170k. That sounds about right to me:
There may be an upside surprise if the May number was low due to new college graduates not yet on the payroll during the survey week. 

The Fed believes this pace of job growth would be consistent with further downward pressure on the unemployment rate, keeping them stuck between concerns they will overheat the economy by undershooting the natural rate of unemployment and that pesky low inflation number. With that in mind, Wall Street anticipates the unemployment rate holds steady at 4.3%, which would likely only provide temporary relief for the Fed. They would be more willing to slow the pace of rate hikes if the unemployment rate held steady and the pace of job growth slowed to something closer to 100k per month. If that happens by the end of the year and inflation remains tepid, I anticipate the Fed would pull back on rate hike expectations for 2018.

That said, my baseline expectation is that economic growth proves sufficient to place further downward pressure on unemployment, leaving the Fed stuck in their current conundrum. 

Last but not least, the Fed will be carefully watching measures of wage growth. Wage growth softened in recent months, suggesting that the goal of full employment remains elusive. That said, some of that weakness might be the delayed impact of flattening unemployment in 2016. Hence, the impact of lower unemployment this year on unemployment might still lie ahead. Firming to accelerating wage growth would signal to the Fed that the economy is indeed at full employment as many policymakers suspect. Such confirmation would enable them to dig in their heels on expected rate hikes.