Tim Duy's Fed Watch

Yellen's Odds of Being Reappointed Get Slimmer

The Federal Reserve Bank of Kansas City’s annual Jackson Hole conference offered little direct insight into the path of monetary policy for this year and next. But that doesn’t mean it was a nonevent. Perhaps the biggest takeaway is that the already small odds of Chair Janet Yellen being reappointed by the Trump administration when her term ends in February just got a lot slimmer.

Continued at Bloomberg Prophets...

The Market Is Behaving Much Like It Did in the Past

The prevailing wisdom these days is that markets are behaving in inexplicable ways.

I have a different view. If the market means U.S. equities, the behavior since the Federal Reserve began this tightening cycle has been very consistent with the behavior of past cycles. It's not sure all that complicated -- it’s about consistent economic growth -- and I am pretty sure fighting it is a losing bet.

Continued at Bloomberg Prophets...

Fed Has Good Reason to Expect Faster Wage Growth

Federal Reserve officials must think that something soon has to give in this economy. The current equilibrium, characterized by low inflation, low unemployment, low wage growth and high corporate profit margins, isn’t sustainable indefinitely, but they don’t know how or when it will crack.

Continued at Bloomberg Prophets...

Retail Sales, Dudley, Wages

Some quick thoughts for the day.

First, New York Federal Reserve President William Dudley gave an extended interview to the Associate Press. Definitely worth the time to read. Some highlights:

1.) Dudley never put a Trump bump in his forecast, so his forecast is essentially unchanged:

 I think we’re still on the same trajectory we’ve been on for several years. Above trend growth, gradually tightening labor market, inflation -- somewhat below our objective -- but we do expect as the labor market continues to tighten, to see firmer wage gains and that will ultimately filter into inflation moving up towards our 2% objective.

2.) He expects inflation numbers to improve. He wants us to ignore the year-over-year numbers (of course, recent month-over-month numbers are not great):

Well, the reason why inflation won’t get up to 2% very quickly on a year-over-year basis is because we’ve had these very low inflation readings over the last 4 or 5 months. So it’s going to take time for those to sort of drop out of the year-over-year calculation.

3.) Assuming the forecast continues as he expects, he believes the Fed will hike rates again: 

I think it depends on how the economic forecast evolves. If it evolves in line with my expectations, I would expect -- I would be in favor of doing another rate hike later this year.

4.) Bubble? What bubble?

My own view is that -- I’m not particularly concerned about where our asset prices are today for a couple of reasons. The main one is that I think that the asset prices are pretty consistent with what we’re seeing in terms of the actual performance of the economy.

5.) But - and I think this is important - financial conditions continue to easy despite rate hikes:

Now the reason why I think you’d want to continue to gradually remove monetary policy accommodation, even with inflation somewhat below target, is that 1) monetary policy is still accommodative, so the level of short-term rates is pretty low, and 2) and this is probably even more important, financial conditions have been easing rather than tightening. So despite the fact that we’ve raised short-term interest rates, financial conditions are easier today than they were a year ago.

The stock market’s up, credit spreads have narrowed, the dollar has weakened, and those have more than offset the effects of somewhat higher short-term rates and the very modest increases that we’ve seen in longer-term yields.

6.) Balance sheet normalization is coming:

Well, we obviously have to have the FOMC meeting to make that decision at the next FOMC meeting. But, I don’t think the expectations of market participants are unreasonable. In June, following the June FOMC meeting, we laid out a plan in terms of how we would actually do our balance sheet normalization. How we would allow Treasury and agency mortgage-backed securities to gradually run off our portfolio over time.

And so the plan is out there. It’s been I think generally well-received, and fully anticipated. People expect it to take place. In the last FOMC statement, we said that we expected this to happen relatively soon. So, I expect it to happen relatively soon.

7.) At the end of the day, the balance sheet reduction might amount to very little:

My own view is, if I had to say today, we’re probably going to see a balance sheet five years from now that’s probably in the order of 2-1/2 to 3-1/2 trillion rather than the 4-1/2 trillion dollar balance sheet.

Overall, Dudley continues to adhere to what amounts to the Fed's median forecast, and that means he thinks another rate hike this year is solidly in play.

Separately, retail sales for July were up:

The monthly data is noisy, so be wary that it reflects the true state of spending. The three-month and twelve-month changes (for core sales) are similar at 3.2% and 3.6% respectively and more likely reflect the underlying trend. Basically, the consumer continues to press forward at a modest pace. Stop worrying about consumer spending. It isn't an imminent threat to the outlook.

And why should it be a threat? Like, job growth, wage growth is actually fairly solid. The headline weakness in wage growth is all about demographic shift, at least according to new research from Mary Daly of the Federal Reserve Bank of San Francisco. Via Bloomberg:

Fresh research from the San Francisco Fed provides an explanation: baby boomers. As they retire in droves, their exit from the workforce is distorting the data for average earnings, according to a blog post published Monday on the bank’s website.

“Wage growth isn’t as disappointing as it looks,” Mary Daly, director of economic research at the San Francisco Fed, said in an interview. “Wage growth, when cleaned up, looks consistent with other measures seen in the labor market.”

 The implication is that the labor market low wage growth does not necessarily imply the labor market is weak. It is an artifact of demographic change. That change has been fairly persistent, but at the end of the note Daly holds out some hope that it may be changing:

Overall, these factors have combined to hold down growth in the median weekly earnings measure by a little under 2 percentage points (Figure 2), a sizable effect relative to the normal expected gains.

Most recently, the effect from flows into and out of full-time work has started to tick upward and might be a sign of stronger growth ahead.

We will see.

Finally, you can find my latest at Bloomberg Prophets.

 

Fed Shouldn't View Productivity as an Exogenous Factor

The Federal Reserve has an opportunity to test a hypothesis critical to the health of the U.S. economy: Can persistently loose monetary policy boost the pace of productivity growth? Sadly, for now, an adherence to a strict Phillips curve framework for the economy and fear of financial instability will prevent the Fed from venturing down this path.

Continued at Bloomberg Prophets...

Don't Add To The Fire

Vox has an article out this morning with the title "The real "deep state" sabotage is happening at the Fed." It begins:

Trump administration officials are notorious for their suspicion that a “deep state” of career military, intelligence, diplomatic, or civil service professionals is seeking to sabotage their work. But for a clearer example of sabotage — albeit without much in the way of a conspiracy — Trump would do well to cast his gaze at the Federal Reserve, which, dating back to before his inauguration, has been waging war on an inflationary menace that appears not to exist.

I have no qualms with the criticism that the Fed's is excessively focused on inflation or, more accurately, possibly working with a broken model of inflation. That's fair game. 

What I find disturbing and quite frankly irresponsible is the use of "deep state" language to describe the Fed. This is the language used by the far right to discredit and undermine faith in our government institutions. For the left to adopt the same language adds to the fire already burning. 

Take this language into consideration with the rage already directed against the Federal Reserve. This, for instance:

A Sayre man has been arrested in connection with what authorities says is a foiled plot to blow up a bank building in Downtown Oklahoma City with a truck filled with fake explosives.

Jerry Drake Varnell, 23, of Sayre, initially wanted to blow up the Federal Reserve Building in Washington, D.C., but settled on attempting to detonate a bomb at the BancFirst building at 101 N Broadway in downtown Oklahoma City, according to court documents.

An undercover FBI agent posed as someone who could help Varnell to blow up the building, according to a complaint filed Sunday in U.S. District Court for the Western District of Oklahoma. Varnell allegedly told an FBI informant that he wanted to blow up the Federal Reserve Building in Washington, D.C., with a device similar to the one used in the 1995 Oklahoma City bombing because he was upset with the government.

I am honestly just simply disappointed that Vox chose to add to the hate directed at the Fed by using the inflammatory language of the far right. I have had plenty of criticisms of the Fed over the years. I am concerned that their model of inflation isn't working, and that their estimate of the natural rate of interest is too high. But that type of criticism is a far cry from describing the institution as the "deep state." We have seen time and time again that fomenting that kind of thought only leads to bloodshed. The last thing we need is the left helping to incite another Oklahoma City bombing on Constitution Ave. - or anywhere for that matter.

Multiple Jobholders Are Not A Weak Spot In The Employment Report

Along with every decent employment report comes the efforts to debunk that report. I see that an article from Pedro Nicolaci Da Costa at Business Insider is making the rounds tonight. In it Da Costa directs us to this in particular from Komal Sri-Kumar:

The plight of low-income workers is underlined by yet another statistic. According to BLS numbers, 7.6 million workers held multiple jobs last month, up 2% from 7.4 million in July 2016. The principal reason workers hold more than one position is that no single job provides a sufficient income. In a robust economic recovery, the number of full-time workers should be rising, and the number of workers employed part-time or holding multiple jobs, should decline. The rise in the number of multiple job holders is troubling, and is yet another signal that there is still slack in the labor market. Are we there yet? No, we are still far from full employment.

Let's look at a picture of this one:

Sri-Kumar claims that in a robust economic expansion, the number of multiple job holders should be declining. In other words, multiple job holders should be a countercyclical indicator. But even the most cursory look at the data tells you that the number of multiple job holders is a procyclical indicator. It should rise as the economy gains steam and there is more opportunity for those who need or want second jobs to find such employment.

The trend of multiple job holders is very clearly not a sign of weakness in the economy, but a sign of strength. 

It is also worth noting that as a percentage of the employed, the number of multiple job holders has been in a two decade decline:

Note that the job market of the late 1990's is considered one of the best, yet at the same time the percentage of multiple job holders was rising and high. A decline in the number of multiple job holders, both in absolute and percentage terms, was actually a leading indicator of recession. In other words, if you are concerned about opportunities for those who need or want multiple jobs, you should be hoping these metrics move higher, not lower.

Bottom Line: The rise in the number of multiple job holders is a sign of economic strength, not weakness. Regardless of what the bears might say, the July employment report was solid. Get over it. Worry about the inability of this Administration to deal with a crisis like North Korea instead.

July Employment Recap

The July employment report came in on the high side of expectations and sufficiently strong to keep the Fed's policy plans for this year and next intact despite low inflation. On average central bankers will have a hard time backing down from rate hike plans with job growth still in excess of that necessary to hold unemployment stable. They may believe the economy is not yet at full employment, but they don't want to be too far below their estimate of the neutral interest rate before they hit full employment. And they don't think that point can be very far off.

Nonfarm payrolls gained 209k, solidly above expectations of 180k:

The pace of job growth is easing, but only gradually. The 12-month average was 180k, compared to 205k in July of last year. The unemployment rate edged down to 4.3%, back to the level of June. The labor force participation rate rose, but remains in the range it has enjoyed since 2016:

The Fed will take note that job growth remains in excess of labor force growth. That difference generally drives unemployment lower: 

The big labor force gains occurred at the beginning of 2016, which helped stabilize the unemployment rate. The current dynamic will almost certainly push unemployment lower and past the Fed's comfort levels, probably sooner than later.

The Fed will see hopeful signs in the wage numbers. Average wages grew at a 4.19% annualized rate in July, giving credence to the theory that the slowdown in wage growth earlier this year was temporary:
To be sure though, one month does not a trend make. But the Fed will not be making a decision on one month of data. Balance sheet normalization will almost certainly begin in September (barring a disruptive debt ceiling battle), leaving December for a potential rate hike. If wage data continues to come in  closer to July's number than June's, the Fed will feel more confident that they a.) have the correct estimate of the natural rate of unemployment and b.) that inflation will return to their 2% target over the medium run. Hence, the December rate hike remains in play.

Solid job growth seems likely to continue. That at least is the story told by temporary help payrolls:

We are well past the flattening out of early last year. For those looking for an imminent recession, this isn't showing one. And for those looking for a market crash, look at the similar behavior of this indicator in 1995. As is now well known, that market crash was still a long ways off.

Bottom Line: A solid report that suggests further declines in the unemployment rate in the months ahead. The Fed will want to stay preemptive in this environment. I don't foresee them backing off their rate forecast for this year and next very easily. 

Why These Job Numbers Matter to the Fed

Even though the Federal Reserve is poised to start shrinking its $4.5 trillion balance sheet, the outlook for continued rate increases is very much in doubt following the recent slowdown in inflation. That makes the monthly jobs report on Friday even more important than usual as investors and analysts try to figure out whether the central bank will continue to take its cues from labor market strength rather than inflation weakness as it charts a course for monetary policy.

Continued at Bloomberg Prophets....