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The FOMC meeting today will be a non-event from a policy perspective but we are very curious to see what both the written statement and the Chair will have to say about the unexpected strength of the economy in the first quarter.
It's going to be very hard for Fed Chair Powell's Jackson Hole speech today to satisfy markets, which now expect three further rate cuts by March next year.
In one line: The Fed will use its room for maneuver to ease again next month, but the data don't justify aggressive rate cuts.
In one line: No pushback on the July ease, but it's still a bad idea.
Fed Chair Yellen speaks at Jackson Hole today, at 10:00 Eastern. Her topic is billed as "financial stability", but that does not necessarily preclude remarks on the outlook for the economy and policy.
It would be astonishing if the Fed doesn't raise rates today, and Chair Powell is not in the astonishment business; they will hike by 25bp.
Chair Yellen's speech at Jackson Hole at 10am Eastern time today has the potential to move markets substantially, but that's not our core expectation. It's more likely, we think, that Dr. Yellen will stick to the core FOMC view, which remains that "only gradual increases" in rates will be required, and that rates are "likely to remain, for some time, below levels that are expected to prevail in the longer run".
The tone of Fed Chair Powell's opening comments at the press conference yesterday was much more dovish than the statement, which did little more than most analysts expected.
The Fed yesterday acknowledged clearly the new economic information of recent months, namely, that first quarter GDP growth was "solid", with Chair Powell noting that it was stronger than most forecasters expected.
Fed Chair Powell's semi-annual Monetary Policy Testimony yesterday broke no new ground, largely repeating the message of the January 30 press conference.
The federal debt ceiling was re-imposed last week, with no fanfare, and no reaction in the markets. All eyes were focussed instead on the Fed's rate hike and Chair Yellen's press conference.
The FOMC's view of the economic outlook and the likely required policy response, set out in yesterday's statement and Chair Yellen's press conference, could not be clearer.
The stock market loved Fed Chair Powell's remarks on the economy yesterday, specifically, his comment that rates are now "just below" neutral.
We very much doubt that Fed Chair Powell dramatically changed his position last week because President Trump repeatedly, and publicly, berated him and the idea of further increases in interest rates.
Fed Chair Powell yesterday said about as little as he could without appearing to ignore the turmoil in markets since the President announced his intention to apply tariffs to imports from Mexico: "We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective."
Fed Chair Powell did not specify how many bills the Fed will buy in order boost bank reserves sufficiently to remove the strain in funding markets, but we'd expect to see something of the order of $500B.
Investors focussed last week on Chair Powell's semi-annual Monetary Policy Testimony, but he said nothing much new.
Chair Yellen's final FOMC meeting today will be something of a non-event in economic terms.
Fed Chair Powell delivered no great surprises in his semi-annual Monetary Policy Testimony yesterday, but he did hint, at least, at the idea that interest rates might at some point have to rise more quickly than shown in the current dot plot: "... the FOMC believes that - for now - the best way forward is to keep gradually raising the federal funds rate [our italics]."
We want to revisit remarks from Fed Vice-Chair Clarida last week.
Fed Chair Powell sounded a lot like Janet Yellen yesterday, at least in terms of substance.
Expectations for a March rate hike have dipped since Fed Vice-Chair Clarida's CNBC interview last Friday.
Chair Powell broke no new ground in his semi-annual Monetary Policy Testimony yesterday, repeating the Fed's new core view that the current stance of policy is "appropriate".
At least some investors clearly were expecting Fed Chair Powell yesterday to offer a degree of resistance to the idea that a rate cut at the end o f this month is a done deal.
Chair Yellen has become quite good at not giving much away at her semi-annual Monetary Policy Testimony.
The Fed's unanimous vote for a 25bp rate hike was overshadowed by the bump up in the dotplot for next year, with three hikes now expected, rather than the two anticipated in the September forecast. Chair Yellen argued the uptick in the rate forecasts was "tiny", but acknowledged that some participants moved their forecasts partly on the basis that fiscal policy is likely to be eased by the new Congress.
We're not expecting drama from Chair Yellen's semi-annual Monetary Policy Testimony in the Senate today. Dr. Yellen will want to keep alive the idea of a rate hike next month, but she will not signal that action is likely, given the continuing lack of clarity on the path of fiscal policy.
Fed Chair Powell's semi-annual Monetary Policy Testimony today will likely re-affirm that policymakers still think "gradual" rate hikes are appropriate and that the risks to the economy remain "roughly balanced".
The Fed's action, statement, and forecasts, and Chair Yellen's press conference, made it very clear the Fed is torn between the dovish signals from the recent core inflation data, and the much more hawkish message coming from the rapid decline in the unemployment rate.
Fed Chair Yellen delivered no great surprises in her semi-annual Monetary Policy Testimony, though she certainly was clear on her attitude to the balance sheet. The Fed does not want to "...use the balance sheet as an active tool of monetary policy."
Fed Chair Yellen today needs to strike a balance between addressing investors' concerns over the state of the stock market and the risks posed by slower growth in Asia, and the tightening domestic labor market.
We'd be surprised to see any serious shift in the tone of Fed Chair Powell's semi-annual Monetary Policy Testimony today compared to the FOMC statement and press conference just three weeks ago.
After three days of jaw-dropping actions from President Trump, the position seems to be this: The U.S. will apply 15% tariffs on imported Chinese consumer goods, rather than the previously promised 10%, effective in two stages on September 1 and December 15.
In the wake of last week's rate increase, the fed funds future puts the chance of another rise in September at just 16%. After hikes in December, March and June, we think the Fed is trying to tell us something about their intention to keep going; this is not 2015 or 2016, when the Fed happily accepted any excuse not to do what it had said it would do.
The rising trend in U.S. oil production was interrupted only briefly by the hurricanes.
The Fed will leave rates unchanged today.
The Fed is on course to hike again in December, with 12 of the 16 FOMC forecasters expecting rates to end the year 25bp higher than the current 2-to-21⁄4%; back in June, just eight expected four or more hikes for the year.
The commentariat was very excited Friday by the inversion of the curve, with three-year yields dipping to 2.24% while three-month bills yield 2.45%.
The spike in the May core CPI, and its likely echo in the core PCE, won't stop the Fed easing at the end of this month.
A trade deal with China is in sight. President Trump tweeted Sunday that the planned increase in tariffs on $200B of Chinese imports to 25% from 10%, due March 1, has been deferred--no date was specified-- in light of the "substantial progress" in the talks.
New York Fed president Dudley toed the Yellen line yesterday, arguing that the effects of "...a number of temporary, idiosyncratic factors" will fade, so "...inflation will rise and stabilize around the FOMC's 2 percent objective over the medium term.
From a bird's-eye perspective, the argument for continued steady Fed rate hikes is clear.
The biggest single problem for the stock market is the president.
The risk of higher US rates put LatAm currencies under pressure during the first half of the week, before the US FOMC meeting on Wednesday. But they recovered some ground yesterday, following the Fed's decision to leave rates on hold.
The Fed wants price stability--currently defined as 2% inflation--and maximum sustainable employment.
Judging by conversations we have had with investors since October, the idea that the Fed will be willing to let inflation overshoot the 2% target for a time has become received wisdom in the markets.
We're nudging down our estimate of Q2 GDP growth, due today, by 0.3 percentage points to 1.8%, in the wake of yesterday's array of data.
Full employment is a deceptively simple-sounding concept. If everyone who wants a job has one, the economy is at full employment, right? Anything less tends to raise eyebrows among non-economists, whether the people who want a job are formally inside the labor force, or have dropped out but would come back if they thought they could find work.
We've had pushback from readers over our take on the likelihood of a trade deal with China in the near future.
Now that the Fed has abandoned the idea of raising rates this year, despite 3.8% unemployment and accelerating wages, it is very exposed to the risk that the bad things it fears don't happen.
If the only manufacturing survey you track is the Philadelphia Fed report, you could be forgiven for thinking that the sector is booming.
It would be easy to characterize the Fed as quite split at the July meeting.
The FOMC did the minimum expected of it yesterday, raising rates by 25bp--with a 20bp increase in IOER--and dropping one of its dots for 2019.
We're expecting to learn today that existing home sales rose quite sharply in July, perhaps reaching the highest level since early 2018.
We expect the Fed today to shift its dotplot to forecast one rate hike this year, down from two in December and three in September.
The recent increases in single-family housing construction are consistent with the rise in new home sales, triggered by the substantial fall in mortgage rates over the past year.
We would be astonished if the FOMC meeting starting today does not end with a 25bp rate hike.
We expect to learn today that the economy expanded at a 2.1% annualized rate in the fourth quarter, slowing from 3.4% in the third.
The most striking feature of the Fed's new forecasts is the projected overshoot in core PCE inflation at end-2019 and end-2020, which fits our definition of "persistent".
The hawks clearly tried hard to persuade their more nervous colleagues to raise rates yesterday. In the end, though, they had to make do with shifting the language of the FOMC statement, which did not read like it had come after a run of weaker data.
The Fed headlines yesterday carried no real surprises; rates were cut by 25bp, with a promise to take further action if "appropriate to sustain the expansion".
The probability of a rate hike on June 14, as implied by the fed funds future, has dropped to 90%, from a peak of 99% on May 5.
The trend rate of increase in private payrolls in the months before Hurricane Katrina in 2005 was about 240K per month.
The two key planks of the argument that a substantial easing of fiscal policy won't be inflationary are that labor participation will be dragged higher, limiting the decline in the unemployment rate, while productivity growth will rebound, so unit labor costs will remain under control.
In recent years only one event has made a material difference to the growth path of the U.S. economy, namely, the plunge in oil prices which began in the summer of 2014. The ensuing collapse in capital spending in the mining sector and everything connected to it, pulled GDP growth down from 2½% in both 2014 and 2015 to just 1.6% in 2016.
Fed policymakers surprised no one with their May 1 statement, which acknowledged the surprisingly "solid " Q1 economic growth--at the time of the March 19-to-20 meeting, the Atlanta Fed's GDPNow model suggested Q1 growth would be just 0.6%--but stuck to its view that low inflation means the FOMC can be "patient".
On a trade-weighted basis, sterling has dropped by only 1.5% since the start of the month, but it is easy to envisage circumstances in which it would fall significantly further.
It's hard to read the minutes of the April 30/May 1 FOMC meeting as anything other than a statement of the Fed's intent to do nothing for some time yet.
Today's FOMC meeting will be the first non-forecast meeting to be followed by a press conference.
The flow of data pointing to strength in the labor market has continued this week, on the heels of last week's report of a 250K jump in October payrolls.
If the Fed needed further encouragement to raise rates next month, it arrived Friday in the form of solid jobs numbers, a new cycle low for the broad unemployment rate, and a new cycle high for wage growth.
The two big surprises in the September employment report--the drop in the unemployment rate and the flat hourly earnings number--were inconsequential, when set against the sharp and clear slowdown in payroll growth, which has further to run.
No single measure of labor demand is always a reliable leading indicator of the official payroll numbers, which is why we track an array of private and official measures.
In the wake of Wednesday's ADP report, showing a mere 27K increase in private payrolls, we cut our payroll forecast to 100K.
We're sticking to our 220K forecast for today's official payroll number, despite the slightly smaller-than- expected 179K increase in the ADP measure of private employment.
If our composite index of businesses' hiring plans could speak, it would say: "Told you payrolls were going to go nuts at the end of the year."
The return to normal in the March payroll numbers, with a 196K headline increase, is another nail in the coffin of the "imminent recession" theory.
A steep drop in prices for financial services in January was a key factor behind the sharp slowdown in the rate of increase of the core PCE deflator in the first quarter, relative to the core CPI.
We expect August's GDP figures, released on Wednesday, to show that month-to-month growth slowed to 0.1%, from 0.3% in July.
The dip in payroll growth in September was due to Hurricane Florence. We expect a clear rebound in payrolls in October; our tentative forecast is 250K.
Payroll growth in September and October probably won't be materially worse than August's meager 96K increase in private jobs.
A third wave of Covid-19 outbreaks is now underway. The first, in China, is now under control, and the rate of increase of cases in South Korea has dropped sharply. The other second wave countries, Italy and Iran, are still struggling.
The budget sequestration process, which cut discretionary government spending by a total of $114B in fiscal 2013 and fiscal 2014, was one of the dumbest things Congress has done in recent years.
The impending retirement of New York Fed president Dudley creates yet another vacancy on the FOMC.
We have two competing explanations for the unexpected leap in November payrolls. First, it was a fluke, so it will either be revised down substantially, or will be followed by a hefty downside correction in December.
We would be quite surprised if today's official payroll number exceeded the 135K ADP reading; a clear undershoot is much more likely.
It would be astonishing if the May and June payroll numbers looked much like April's strong data, at least in the private sector.
After a week--yes, a whole week!--with no significant new developments in the trade war with China--it's worth stepping back and asking a couple of fundamental questions, which might give us some clues as to what will happen over the months ahead.
It's pretty easy to spin a story that the recent core PCE numbers represent a sharp and alarming turn south.
We'd be very surprised to see anything other than a 25bp rate cut from the Fed today, alongside a repeat of the key language from July, namely, that the Committee "... will act as appropriate to sustain the expansion".
The Fed likely will do nothing today, both in terms of interest rates and substantive changes to the statement. We'd be very surprised to hear anything new on the Fed's plans for its balance sheet.
The chance of a self-inflicted, unnecessary weakening in the economy this year, and perhaps even a recession, has increased markedly in the wake of the president's announcement on Friday that tariffs will be applied to all imports from Mexico, from June 10.
The trade war with China is a macroeconomic event, whose implications for economic growth and inflation can be estimated and measured using straightforward standard macroeconomic tools and data.
The Fed will do nothing to the funds rate or its balance sheet expansion program today.
The stage is set for the Fed to ease by 25bp today, but to signal that further reductions in the funds rate would require a meaningful deterioration in the outlook for growth or unexpected downward pressure on inflation.
The FOMC has gone all-in, more or less, on the idea that the headwinds facing the economy mean that the hiking cycle is over.
If the underlying trend in payroll growth is about 200K, then a weather-depressed 98K reading needs to be followed by a rebound of about 300K in order fully to reverse the hit. But the consensus for today's April number is only 190K, and our forecast is 225K.
The Nikkei services PMI for Japan partly rebounded in January, to 51.6, after it fell sharply to 51.0 in December.
We're expecting a 175K increase in December payrolls today. Our forecast has been nudged down from 190K in the wake of the ADP employment report, which was slightly weaker than we expected.
The June ISM manufacturing index signalled clearly that the industrial recovery continues, with the headline number rising to its highest level since August 2014, propelled by rising orders and production. But the industrial economy is not booming and the upturn likely will lose a bit of momentum in the second half as the rebound in oil sector capex slows.
While we were out, most of the core domestic economic data were quite strong, with the exception of the soft July home sales numbers and the Michigan consumer sentiment survey.
The biggest surprise in the revisions to first quarter GDP growth, released yesterday, was in the core PCE deflator.
It's not our job to pontificate on the merits, or otherwise, of the tax cut bill from a political perspective.
The downshift in core PCE inflation this year has unnerved the Fed, along with the intensification of the trade war and slower global growth.
It would not be fair to describe the FOMC as gridlocked, because that would imply no clear way out of the current position. Members' views of the risks to the economy, the state of the labor market, and the degree of inflation risk are all over the map, and the chance of a broad consensus emerging any time soon is slim.
The FOMC did mostly what was expected yesterday, though we were a bit surprised that the single rate hike previously expected for next year has been abandoned.
Today's JOLTS survey covers August, which seems like a long time ago. But the report is worth your attention nonetheless.
The Fed will raise rates by 25 basis points on Wednesday, but as usual after a widely-anticipated policy decision, most of our attention will be focused on what policymakers say about their actions, and how their views on the economy have changed.
It appears to be something of an article of faith among economic advisors to President-elect Trump that substantial fiscal stimulus will generate faster growth without boosting inflation, because both labor participation and productivity growth will rise.
It's hard to know what will stop the correction in the stock market, but we're pretty sure that robust economic data--growth, prices and/or wages--over the next few weeks would make things worse.
Today's rate hike will be accompanied by a new round of Fed forecasts, which will have to reflect the faster growth and lower unemployment than expected back in September.
Today's November retail sales numbers are something of a wild card, given the absence of reliable indicators of the strength of sales over the Thanksgiving weekend, and the difficulty of seasonally adjusting the data for a holiday which falls on a different date this year.
Monthly core CPI prints of 0.3% are unusual; June's was the first since January 2018, so it requires investigation.
The rundown of the Fed's balance sheet has proceeded in line with the plans laid out b ack in June 2017.
We see clear upside risk to the inflation data due before the FOMC announcement, from three main sources.
The monthly survey of small businesses conducted by the National Federation of Independent Business is quite sensitive to short-term movements in the stock market, so we're expecting an increase in the November reading, due today.
Slowly but surely, it is becoming respectable to argue that central bank policy in the developed world is part of the problem of slow growth, not the solution. We have worried for some time that the signal sent by ZIRP--that the economy is in terrible shape--is more than offsetting the cash-flow gains to borrowers.
The median of FOMC members' estimates of longer run nominal r-star--the rate which would maintain full employment and 2% inflation--nudged up by a tenth in September to 3.0%, implying real r-star of 1%.
For some time now we have argued that collapse in capital spending in the oil sector was the source of most of the softening of activity in the manufacturing and wholesaling sectors last year.
Interest rate expectations continued to fall sharply last week.
Neither the 33K drop in September payrolls nor the 0.5% jump in hourly earnings tells us anything about the underlying state of the labor market.
On the face of it, our forecast of higher core inflation by the end of this year is seriously challenged by the recent data.
The falling unemployment rate and the threat it poses to the inflation outlook mean that the labor market numbers in the NFIB small business survey attract more attention than the other data in the report.
The outcome of the Trump-Xi meeting at the G20 summit was as good as we expected.
The Fed will hike by 25 basis points today, citing the tightening labor market as the key reason to press ahead with the process of policy normalization. We think the case for adding an extra dot to the plot for both this year and next is powerful.
The January core CPI numbers are consistent with our view that the U.S. faces bigger upside inflation risks than markets and the Fed believe.
It's hard to know what to make of the October CPI data, which recorded hefty increases in healthcare costs and used car prices but a huge drop in hotel room rates, and big decline in apparel prices, and inexplicable weakness in rents.
The gap between the official measure of the rate of growth of core retail sales and the Redbook chainstore sales numbers remains bafflingly huge, but we have no specific reason to expect it to narrow substantially with the release of the April report today.
The rate of growth of nominal core retail sales substantially outstripped the rate of growth of nominal personal incomes, after tax, in both the second and third quarters.
Our argument that rates could rise as soon as March has always been contingent on two factors, namely, robust labor market data and a degree of clarity on the extent of fiscal easing likely to emerge from Congress. On the first of these issues, the latest evidence is mixed.
Your correspondent is headed to the beach for the next couple of weeks, with publication resuming on Tuesday, September 4.
A 45bp rise in long-term interest rates--the increase between mid-August and last week's peak--ought to depress stock prices, other things equal.
The Fed was more hawkish than we expected yesterday.
After four straight sub-consensus core CPI readings, we think the odds now favor reversion to the prior trend, 0.2%, over the next few months.
The consensus forecast for the October core CPI, which will be reported today, is 0.2%. Take the over. Nothing is certain in these data, but the risk of a 0.3% print is much higher than the chance of 0.1%.
The core CPI inflation rate rose in April to 2.1% from 2.0%, thanks to unfavorable rounding, despite the below consensus 0.14% month-to-month print.
Today brings a huge wave of data, but most market attention will be on the June CPI, following the run of unexpectedly soft core readings over the past three months.
The third straight 0.3% increase in the core CPI-- that hasn't happened since 1995--was ignored by the Treasury market yesterday, which appeared to be focusing its attention on the ECB.
The 0.242% increase in the January core CPI left the year-over-year rate at 2.3% for the third straight month.
The Fed surprised no-one by raising rates 25bp yesterday and leaving in place the median forecast for three hikes next year and two next year.
July's fifth straight undershoot to consensus in the core CPI was very different the previous four. Only one component--lodging away from home--prevented the first 0.2% month-to-month print since February.
The record 1,178-point drop in the Dow will garner all the headlines today, but a sense of perspetive is in order, despite the chaos. The 113-point, or 4.1%, fall in the S&P 500 was very startling, but it merely returned the index to its early December level; it has given up the gains only of the past nine weeks.
Fed Chair Yellen's Testimony yesterday pretended the election hadn't happened, and ignored the incoming administration's plans for a huge fiscal stimulus. She did address the issue under questioning, though, pointing out that fiscal stimulus could have inflationary consequences and that the Fed will have to factor-in to its decisions whatever Congress decides to do to taxes and spending.
Fed Chair Yellen said nothing very new in the core of her Monetary Policy Testimony yesterday, repeating her view that rates likely will have to rise this year but policy will remain accommodative, and that the labor market is less tight than the headline unemployment rate suggests. The upturn in wage growth remains "tentative", in her view, making the next two payroll reports before the September FOMC meeting key to whether the Fed moves then.
LatAm markets reacted well to the U.S. Fed's decision to increase the funds rate by 25bp, to 1-to-1¼%, on Wednesday. Currencies moved only slightly after the decision and asset markets were relatively stable. Yesterday, some currencies retreated marginally as investors digested the relatively hawkish message from the Fed and Chair Yellen's press conference.
Fed Chair Yellen said something which sounded odd, at first, in her Q&A at the Senate Banking Committee last Tuesday. It is "not clear" she argued, that the rate of growth of wages has a "direct impact on inflation".
Chair Yellen remains as committed as ever to the idea that the tightening labor market will eventually push up inflation, but the unexpectedly weak core CPI readings for the past four months have complicated the picture in the near-term.
As we write, 25 Conservative MPs have confirmed publicly that they have submitted no-confidence letters to the Chairman of the 1922 Committee. That's 23 short of the 48 required to trigger a leadership contest, though some MPs might have submitted letters without making it public.
After a slew of media reports in recent days, we have to expect that the president will today announce that Fed governor Jerome Powell is his pick to replace Janet Yellen as Chair.
Fed Chair Yellen speaks to the Economics Club of Washington, D.C., at 12.25 Eastern today, a day before she appears before the Joint Economic Committee of Congress at 10.00 Eastern. These will be her last public utterances before the FOMC meeting on December 16. Dr. Yellen won't say anything which could be interpreted as seeking to front-run the outcome of the meeting; that's not her style. But we expect her clearly to repeat that the Fed's decision will depend on whether progress has been made since October towards the Fed's twin objectives of maximum employment and 2% inflation.
We expect Greece to do what it needs to do by Wednesday to secure its third bailout, and, judging by her speech in Cleveland last Friday, so does the Fed Chair. It's always risky to assume blithely that European politicians will do the right thing in the end, and they seem absolutely determined to humiliate Greece before writing the checks, but a completed deal is the most likely outcome.
If Fed Chair Yellen's objective yesterday was to deliver studied ambiguity in her Testimony--and we believe it was--she succeeded. She offered plenty to both sides of the rate debate. For the hawks, she noted that unemployment is now "...in line with the median of FOMC participants' most recent estimates of its longer-run normal level", and that inflation is still expected to return to the 2% target, "...once oil and import prices stop falling".
Fed Chair Yellen made it clear in last week's press conference that she is not convinced the increase in core inflation will persist: "I want to warn that there may be some transitory factors that are influencing [the rise in core inflation]... I see some of that is having to do with unusually high inflation readings in categories that tend to be quite volatile without very much significance for inflation over time.
Back in April 2012, Janet Yellen--then Fed Vice-Chair--spoke in detail about the labor market and monetary policy. The key point of her labor market analysis was that it was impossible to know for sure how much of the increase in unemployment--at the time, the headline rate was 8.2%--was structural, and how much was cyclical.
After seemingly endless speculation, the confidence vote in Theresa May's leadership of the Conservative party finally has been triggered following the submission of at least 48 letters by disgruntled MPs to the Chairman of the 1922 Committee.
Chair Yellen broke no new ground in her Testimony yesterday, repeating her long-standing view that the tightening labor market requires the Fed to continue normalizing policy at a gradual pace.
We are a bit uneasy about today's data on economic activity. The NFIB index of activity in the small business sector is likely to undershoot consensus expectations, while retail sales are something of a black hole, at least at the core level, where we have no reliable month-to-month advance indicators. Our bullish view on the underlying state of the economy, and its likely second-half performance, hasn't changed, but perceptions count in the short-term and these reports will help set the market mood just ahead of Chair Yellen's Testimony tomorrow.
In yesterday's Monitor we set out the risk that accelerating wages will force the Fed to raise rates more quickly than expected, but we didn't have space to address the underlying premise of this story, namely, the idea that inflation is largely a cost-push phenomenon. From the perspective of fixed income investors, it might not seem to matter whether this is a realistic description of the inflation process, because Fed Chair Yellen believes it wholeheartedly, and her hands are on the levers of monetary policy.
A huge wave of data will break over markets this week, along with the FOMC meeting, new dot plots and Chair Yellen's press conference. But today is calm, with no significant data releases and no Fed speeches; policymakers are in purdah ahead of the meeting.
Federal Reserve Chair Janet Yellen's testimony this week reinforced our view that the first U.S. rate hike will be in June. The transition to higher U.S. rates will require an unpleasant adjustment in asset prices in some LatAm countries.
Speeches by Chair Yellen and Vice-Chair Fischer give the two most important Fed officials the perfect platform today to signal to markets whether rates will rise this month.
Former Treasury Secretary and thwarted would-be Fed Chair Larry Summers has been arguing for some time that the Fed should not raise rates "...until it sees the whites of inflation's eyes". As part of his campaign to persuade actual Fed Chair Yellen of the error of her intended ways, he argued at the World Economic Forum in September that the strong dollar has played no role in depressing inflation. Never one to miss an opportunity to diss the competition, he wrote that Stanley Fischer's view that the dollar has indeed restrained inflation is "substantially weakened" by the hard evidence. Dr. Summers' view is that inflation is being held down by other, longer-lasting factors, principally the slack in the lab or market, rather than the "transitory" influences favored by the Fed.
Today brings a ton of data, as well as an appearance by Fed Chair Powell at the Economic Club of New York, in which we assume he will address the current state of the economy and the Fed's approach to policy.
Fed Chair Yellen yesterday reinforced the impression that the bar to Fed action in December, in terms of the next couple of employment reports, is now quite low: "If we were to move, say in December, it would be based on an expectation, which I believe is justified, [our italics] that with an improving labor market and transitory factors fading, that inflation will move up to 2%." The economy is now "performing well... Domestic spending has been growing at a solid pace" making a December hike a "live possibility." New York Fed president Bill Dudley, speaking later, said he "fully" agrees with Dr. Yellen's position, but "let's see what the data show."
Fed Chair Yellen's speech Friday was remarkably blunt: "Indeed, at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate."
Stanley Fischer said something interesting and potentially very revealing in the Q&A following his speech Tuesday afternoon at the Council on Foreign Relations. The Fed Vice-Chair argued that wage increases of 3% are "where people would like to be", meaning, presumably, that he believes sustained wage gains at this pace are consistent with the Fed's 2% medium-term inflation forecast.
We're guessing Fed Chair Yellen would have preferred to have another acceleration in hourly earnings and a dip in the unemployment rate along side the hefty 211K leap in November payrolls, but no matter. At its October meeting, the Fed wanted to see "some further improvement in the labor market", and by any reasonable standard a 509K total increase in payrolls in two months fits the bill.
Fed Chair Yellen said in her press conference last week that she has "...been surprised that housing hasn't recovered more robustly than it has. In part I think it reflects very tight credit--continuing tight credit conditions for any borrower that doesn't have really pristine credit... my hope is that that situation will ease over time".
Fed Chair Yellen's speech in Cleveland yesterday elaborated on the key themes from last week's FOMC meeting.
A thought, ahead of Chair Yellen's Testimony tomorrow. Conventional wisdom has it that the terminal Fed funds rate in this cycle will b e much lower than in the past--the Fed thinks 3¾%, compared to 5.25% in 2007, and 6.5% in 2000--reflecting the long-lasting legacy of the crash, particularly in household balance sheets.
We pointed out in yesterday's Monitor that Fed Chair Yellen appears to be putting a good deal of faith in the idea that the recent upturn in core inflation is temporary. She argued that "some" of the increase reflects "unusually high readings in categories that tend to be quite volatile without very much significance for inflation over time".
It's hard to imagine that Fed Vice-Chair Dudley would choose to say yesterday that he finds the case for a September rate hike "less compelling than it was a few weeks ago" without having had a chat beforehand with Chair Yellen. Mr. Dudley pointed out that the case "could become more compelling by the time of the meeting", depending on the data and the markets, but he also argued that developments in markets and overseas economies can "impinge" on the U.S., and that there "...still appears to be excess slack in the labor market". These ideas, especially on the labor market but also on the impact of events overseas, are not shared by the hawks, but we can't imagine Mr. Dudley disagreeing in public with Dr. Yellen. We have to assume these are her views too.
Fed Chair Yellen is a committed believer in the orthodox idea that inflation is largely a cost-push phenomenon, and that the most important cost, by far, is labor. So in order to predict what Dr. Yellen might say about the outlook for Fed policy in her Testimony today--beyond the language of the January FOMC statement--we have to take a view on her assessment of the state of the labor market.
Chair Yellen's Testimony sought clearly to tell markets that the Fed has upgraded its view on growth, and the state of the labor market. After reading the first few paragraphs, which focussed clearly on the good news, though peppered with the usual caveats, the door was open for the section on policy to signal unambiguously that the Fed is close to its first tightening.
When Fed Chair Powell said last week that the "surprise" weakness in the official retail sales numbers is "inconsistent with a significant amount of other data", we're guessing that he had in mind a couple of reports which will be updated today.
Fed Chair Yellen set out a robust and detailed defense of the orthodox approach to monetary policy in her speech in Amherst, MA, yesterday afternoon. Her core argument could have come straight from the textbook: As the labor market tightens, cost pressures will build. Monetary policy operates with a "substantial" lag, so waiting too long is dangerous; the "...prudent strategy is to begin tightening in a timely fashion and at a gradual pace".
Chief US economist Ian Shepherdson on the latest Jobs report
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