Tim Duy's Fed Watch

Fed Meeting the Nonevent of the Week

Newsletter version here…

Central bankers will meet this week, but only to sign off on the existing policy stance. Although it pains this fedwatcher to admit, the FOMC meeting is arguably the least important event of the week. It competes with a slew of critical data, including the employment report for October, to be released Friday. Plus, we should learn President Trump’s pick to lead the Fed when Yellen’s term expires next February. An FOMC meeting widely expected to yield no change in policy and likely little in the accompanying statement simply can’t compete with this week’s news flow.

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In Defense of the Conventional Wisdom

Let’s revisit this from San Francisco Federal Reserve Resident John Williams:

If you look until 2015 or so, the inflation data basically followed our models, emphasizing the role of weakness in the economy. Where this mystery has happened is really in the last year or two. I view both inflation picking up faster than expected in early 2017 and now the pullback as just part of the variability that’s going to happen. I don’t see any signs that somehow the inflation process is fundamentally changed.

I’ve been doing this a long time, and the Phillips curve has been declared dead far more times than Mark Twain.

This is representative of the conventional wisdom at the Fed, summed up succinctly as adherence to a basic expectations-augmented Phillips curve as a primary policy guide. As unemployment falls toward and below full employment, capacity constraints in the economy tighten and eventually create inflationary pressures. The central bank needs to offset these pressures via tighter policy to contain inflation and maintain inflation expectations, the center of gravity for actual inflation over time.

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Incoming Data Supportive of December Rate Hike

If we ignore inflation, then nothing is really standing in the way of a rate hike in December. Of course, given that arguably the primary job of a central bank is to meet its definition of price stability, the Fed shouldn’t really ignore inflation. Policymakers, however, would counter that they are not ignoring inflation. They are simply favoring the inflation forecast over actual inflation. And they would further argue they have good cause – with the economy chugging along, it is only a matter of time before resource constraints become evident and price pressures rise. That’s their story, and they are sticking to it.

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Is The Fed Setting Itself Up To Fail In The Next Recession?

The Federal Reserve remains committed to a December rate hike, persistent low inflation not withstanding. With unemployment below Fed estimates of its longer-run natural rate, most FOMC participants do not need evidence of stronger inflation to justify further rate hikes. Ongoing solid job growth will be sufficient cause for tighter policy, especially in what they perceive to be an environment of loosening financial conditions. The main risk from this scenario is that the US economy enters the next recession with diminished inflation expectations, which could further hobble central bankers already facing the prospect of returning to the effective lower bound in the next cycle.

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No Better Than The Rest of Us

Newly minted Nobel laureate Richard Thayler weighed in on equities today. Via Bloomberg:

A buoyant and complacent stock market is worrying Richard H. Thaler, the University of Chicago professor who this week won the Nobel Prize in economics.

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping,” Thaler said, speaking by phone on Bloomberg TV. “I admit to not understanding it.”...

...“I don’t know about you, but I’m nervous, and it seems like when investors are nervous, they’re prone to being spooked,” Thaler said, “Nothing seems to spook the market” and if the gains are based on tax-reform expectations, “surely investors should have lost confidence that that was going to happen.”

Riskiest moments of our lives, hmm. At a now seemingly long ago meeting of the Oregon Council of Economic Advisors, a more experienced member quipped that there is no more uncertainty than there has ever been. That individual  remembered, for example, the 60's and the Cuban Missile Crisis. So while this is a risky moment to be sure, we have had other risky, and perhaps riskier, times to contend with.

Also, note the results of a quick Google search of Thalyer's fellow Nobel laureate, Robert Shiller:

Think about that record, and think about the fact that Shiller is a noted expert in bubbles.

None of this should is meant to any way meant to diminish the accomplishments of Thayler and Shiller. Winning the Nobel prize in economics is something I am fairly certain I will not achieve. It's just to say that before you act on the market advise of a Nobel laureate, it is worth considering if they can really forecast any better than the rest of us.

Kevin Warsh, Very Serious Person

Scott Sumner is perplexed by Fed chair candidate Kevin Warsh. He reads the 2010 FOMC transcripts and finds Warsh explaining:

First, my views on policy. As I said when we met by videoconference, my views are increasingly out of step with the views of most people around this table. The path that you’re leading us to, Mr. Chairman, is not my preferred path forward. I think we are removing much of the burden from those that could actually help reach these objectives, particular the growth and employment objectives, and we are putting that onus strangely on ourselves rather than letting it rest where it should lie. We are too accepting of dangerous policies from others that have been long in the making, and we should put the burden on them.

I can think, Mr. Chairman, of a tough weekend that the Europeans had, particularly your counterpart at the ECB, in the spring or summer, when we all knew that the European Central Bank, rightly or wrongly, was going to take action. But Jean-Claude Trichet did not take action until very late that Sunday night, until the fiscal authorities did their part. He thought that if on Friday night he were to say all of the things he’d be willing to do, he’d be taking the burden off the fiscal authorities. He chose to wait. I think we would be far better off waiting. If we proceed on this path, as I suspect we will, I would still encourage you to put the burden where it rightly belongs, which is on other policymakers here in Washington, and to do so in a way that is respectful of different lines of responsibility.

Sumner is understandably scratching his head, trying to figure out what Warsh is getting at:

His reasoning process is poor and he lacks good communication skills.  He has very poor judgment when interpreting data.  I really don’t know what he’s trying to say here, but the reference to Trichet is interesting.  Trichet was trying to encourage fiscal authorities to adopt more contractionary fiscal policies, not expansionary policies.  Trichet did not want to “bail out” expansionary policies with ultra-low interest rates, and Warsh seems to be endorsing Trichet’s approach.  And given Warsh’s reputation as a conservative, and the massive deficits being run by Obama back in 2010, I find it odd that Warsh would be advocating fiscal stimulus, as Brannon suggests.  But again, the passage is so garbled that I could easily be wrong.

I don’t think Warsh was advocating for more fiscal stimulus at this meeting. Warsh is a Very Serious Person, and all Very Serious People know that deficits are bad. I believe that Warsh was at this juncture advocating a Trichet-style approach to the crisis, using the independence of the central bank to force the fiscal authorities to rein in those bad deficits, because of course everything wrong in the economy can be tied back to deficit spending. All Very Serious People know this. Of course, Trichet’s approach proved to be disastrous, which is why Sumner is rightfully puzzled when hearing a Fed governor suggest the same.

Sadly, Warsh was not the only Fed official who advocated such an approach. Warsh is apparently cut from the same cloth as the person I believe was the worst regional bank president in recent memory. Recall when the FOMC statement contained this sort of reference:

Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth.

Of course, if you bothered to know what the FOMC was saying, you knew the complaint was that they believed monetary policy had reached its limits to stimulate the economy, and that faster growth required a more stimulative monetary policy.

Then Dallas Federal Reserve President Richard Fisher either didn’t understand what the FOMC said, or deliberately misinterpreted the FOMC. In a 2013 speech, Fisher says:

Even if we at the Dallas Fed are right and the overall outlook for the economy is better than the current dashboard or the conventional prognostications of economists, there exists a formidable brake on growth. It was referred to point-blank in the last statement issued by the FOMC: “…fiscal policy is restraining economic growth.”

Fiscal policy is inhibiting the transmission of monetary policy into robust job creation…

…The propensity of members of Congress has been to spend in excess of revenues to give pleasure to their constituents and garner their affection…Until the Congress and the president provide a clear road map as to how fiscal rectitude will be implemented, this lack of credible details for limiting the debt-to-GDP ratio and reengineering fiscal policy to stimulate rather than constrain growth is creating undue uncertainty about future tax rates, future government purchases, future retiree benefits and all manner of factors that impact employment and economic growth. Meanwhile, the divisive nature and petty posturing of those who must determine the fiscal path of the nation is further undermining confidence and limiting the effectiveness of monetary policy…

…I argue that the Fed has no hope of moving the economy to full employment unless our fiscal authorities get their act together…Until then, I argue that the Fed is, at best, pushing on a string and, at worst, building up kindling for a massive shipboard fire of eventual inflation.

These aren’t the kind of people you want in charge of monetary policy. We need policymakers that understand their role is not to withhold monetary stimulus to force fiscal authorities to pursue countercyclical policy simply because Very Serious People know that deficit spending is always bad and cutting deficits is the solution to every problem. Monetary policy is about independently assessing the economy and enacting the policy necessary to maintain full employment and price stability. And oftentimes that means taking fiscal policy as an exogenous factor.

What is particularly discouraging is that neither Warsh nor Fisher appears to understand that during a recession, at a minimum automatic stabilizers themselves will swell the deficit. Taking aim at the deficit in such times is naive at best, deliberately spiteful at worst.

My concern remains that a Fed with someone like Kevin Warsh at the helm would prove to be disastrous for Wall Street and Main Street alike when the next recession hits. Neither group needs a central banker that believes a recession is an opportunity to inflict more pain.

On Track For a December Rate Hike

The headline figure on nonfarm payrolls report came in well below already withered expectations, but the disappointment was more than compensated for in the details of both the establishment and household survey. The Fed is looking for data that allows them to overlook the weak inflation data. This was just that sort of data

Continued as a PDF newsletter here or blog below... 

Nonfarm payrolls sank by 33k, and prior months were revised down. The three-month average is just 91k, which would put the job growth in-line with the range Fed officials believe is consistent with a steady unemployment rate.

But there was little doubt that Hurricanes Harvey and Irma distorted the data, with a particularly large impact on leisure and hospitality numbers. That sector lost 111k employees during the month and looks to have borne the brunt of the impact.

Interestingly, non-farm payrolls excluding leisure and hospitality remain in the range of recent trends. Like overall nonfarm payrolls, the pace of growth entered a gradual slowing phase in 2015. This behavior looks consistent with what would be expected as the economy approach full employment and labor becomes more difficult to find.  

Speaking of full employment, the unemployment rate fell to 4.2%. Recall that in the Fed’s latest Summary of Economic Projections, policymakers projected the unemployment rate to fall to 4.3% by the end of the year. We are a little ahead of schedule, it seems. Note that according to the Bureau of Labor Statistics, the hurricanes did not impact the estimate of the unemployment rate. 

The decline of the unemployment rate should not be a surprise. Job growth continues to track above labor force growth, a situation that typically results in a falling unemployment rate. Moreover, the Fed’s unemployment forecast always seemed suspect. The forecast GDP growth rate through 2019 exceeds potential GDP growth; this would on average suspect greater downward pressure on unemployment than implied by the Fed’s forecast.

An unemployment rate at 4.2% will rattle Fed officials already worried about pushing too far below full employment under the current projections. This will go a long way toward offsetting their nagging worries about low inflation. 

The pace of wage gains accelerated sharply in September. Composition effects due to the loss of lower paid leisure and hospitality jobs might account for part of the gains. But take note of two points. First, hourly wages have generally seen upward revisions in recent months (the September vintage overlaps the August vintage, so I excluded the latter). Second, wage gains in the third quarter look more consistent and broad-based than the rest of the year. 

Hence, we should not discount the possibility that in these wage numbers we see the lagged impact of unemployment running below its longer run rate. Certainly, we need more data to be certain. It would be unwise to read too much into what we know is a hurricane-muddled report. But Fed officials will tend toward this interpretation.

Finally, note that temporary help payrolls continue to climb, suggesting that while employment growth might be softening as the expansion matures, but the economy remains in the expansion and is not poised to turn toward recession. 

Atlanta Federal Reserve President Raphael Bostic offered an assessment of the labor report that I think will be largely shared by his colleagues. Via Bloomberg:

“We knew the hurricanes were really going to give a hit to some of these top line numbers,’’ Bostic said after a speech in Austin, Texas. “The numbers underneath are actually quite interesting. They suggest some of the strength we were starting to see at the beginning of August, the storms didn’t completely wash them out.”

Bostic looks ready to support a December rate hike, assuming the economy continues to post solid numbers. He also downplayed inflation concerns:

“We have seen a slight decline, I think, but nothing that would suggest there has been something fundamental that has changed in how consumers are viewing the marketplace,’’ he said.

Inflation continues to rattle Dallas Federal Reserve President Robert Kaplan. Via Reuters:

“I would like to see more evidence of progress in reaching our inflation objective,” he said, reiterating his concern that globalization and technology are keeping inflation muted, despite unemployment that sank in September to 4.2 percent.

Kaplan votes this year. Although he is among the group concerned about low inflation, he will likely not dissent against a December rate hike if the remainder of the data, on average, sustains a rosy outlook.

St. Louis Federal Reserve President James Bullard stuck to his desire to hold rates steady, worried that the Fed risks pushing inflation expectations lower with additional rate hikes. He wants more proof that inflation is heading higher before the Fed acts. Via Reuters:

“The December meeting is going to be too early to make a determination on whether inflation is coming back. I don’t see how we can get the data on that. I am getting more concerned that we might make a policy mistake.”

The data calendar is a bit slower this week. Look for the JOLTS report (Wednesday), inflation indicator reports PPI (Thursday) and CPI (Friday), and readings on the demand side of the economy from retail sales and business inventories (both on Friday). 

In addition, we have plenty of Fed speakers, including regional Presidents Kashkari (Tuesday), Evans (Wednesday), Bostic (Thursday), and Rosengren and Kaplan (Friday). I don’t think we will see anything new from these speakers regarding monetary policy. Federal Reserve Governor Jerome Powell speaks Thursday (keynote address on emerging markets) and Friday (“Are Rules Made to be Broken? Discretion and Monetary Policy,” an event for which I foolishly forgot to make an effort to attend). Neither speech will likely give direct policy guidance, but with Powell rumored to be a contender for the top spot at the Fed, they will offer additional opportunity to explore his thinking. 

Bottom Line: December rate hike still a go; low unemployment outweighs low inflation for now. That will change next year if job growth slows further and unemployment stabilizes.

Employment Report Expected to Disappoint

The employment report for September will be released this morning. It is widely expected to disappoint as it comes in the wake of a tough hurricane season. But those weak numbers are not expected to dissuade the Fed from hiking in December. And unexpectedly strong numbers would only help prod along those officials getting cold feet from the weak inflation data.

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Hurricanes Help Boost Data While Powell Reportedly Rises to The Top of The Pack

The ISM manufacturing report for September came in stronger than expected. To be sure, hurricane impacts accounted for some of the boost, particularly in supplier deliveries and prices; anecdotal responses made this clear. But it isn’t all hurricanes. Manufacturing has been gaining steam since last year. The sector continues to throw off the 2015/2016 weakness associated with the oil price decline and rise in the dollar. I often feel this improvement has been overlooked.

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Fed Poised To Downplay Weak Data

 

Big data week ahead that ends with the employment report for September. Considering the ongoing inflation weakness, one would think the Fed would be looking for a series of very strong job reports to justify a rate hike in December. But with Fed officials largely convinced that the soft inflation numbers are transitory, a middling jobs report would likely be sufficient to keep them on track, and even a weak report if they can attribute disappointing data to the busy hurricane season.

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