Big changes, and all good news. So you can stop reading now.
The Fed seems to have changed policy, possibly in some long-term ways, and its apparent shift may be real, as opposed to misstatement or fog (see below).
Brand-new economic data from January is pink-of-health, no harm from the Shutdown except to the families involved. Net of prior-months’ revisions, January payrolls grew by nearly 250,000 jobs, almost double the market forecast and two-and-a-half times the Fed’s (prior?) speed limit. The ISM survey of purchasing managers rebounded from a fall slide, happily rising to 56.6 from 54.1 in December and expected to have been unchanged.
It is in the interest of both Xi and Trump to announce a trade deal and mutual victory, even if nothing happens but a gazillion tons of soybeans bought and dumped into the South China Sea. Intervention in Venezuela is a good idea and a safe place for a foreign policy adventure. The US economy is proving impervious to political nonsense.
Given all of this good news, rates should be rising. Not. Which is a good spot to switch to the Fed’s big week.
Few things in finance are more fun than a mystery. Sherlock Holmes used reasoning on a narrow path to divine a solution. Since the rest of us are not that good, try bracketing linked to probability — this way so far but no farther, then over there, solution in the middle somewhere — and solving by exclusion. If not the butler, the gardener, the maid, or the cook, then the chauffeur!
The Fed mystery at hand: seven weeks ago after hiking the cost of money to 2.50% the Fed said, “The Committee judges that some further gradual increases… will be consistent” with objectives. Markets expected the 2.50%, but not at all the “further,” and promptly imploded. The statement after Wednesday’s meeting dropped “further” altogether in favor of “maintain the target range,” and “In light of… muted inflation pressures the Committee will be patient.” What happened to cause this extraordinary reversal?
One trail leads to Chauffeur Powell, who misspoke last fall, indicating a tighter Fed than was the case. Perhaps the December 19th statement was likewise over-hawked. Everyone respects this driver, and in a time of uncertain leadership we must trust somebody. Professionals are still skittish when listening to the Chauffeur, fearful of a re-reversal, but this week’s performance was an overwhelming set of signals of policy change. Among them: the loud rebellion among senior passengers in the Fed Limo after the December 19 false-hawk. We never see a half-dozen Fed officials follow the Chair to say, no matter what he said, that’s not what we’re doing. But we did last month.
Over-hawk, rebellion and correction aside, what truly has changed? The Chauffeur: “…The case for raising rates has weakened somewhat.” But, “This change was not driven by a major shift baseline case for the economy.” Then much mumbling about crosscurrents. As an explanation for a reversal from more hikes baked in the cake to no cake at all in a little more than a month… more word games than clarity. Stick with the event, Fed on open-ended hold.
Smart Greg Ip at the WSJ wonders if the Fed is worried about a “fundamentally fragile” economy.
Tim Duy, sharp professor of Fed-watching sees the “bar much lower” for a rate cut than new hikes.
Another very bright Fed-watcher, the best of this generation and maybe any, Nick Timiraos of the WSJ notes the Fed dropped all mention of the economy as “balanced, or tilted toward strength, or underperformance,” and reads concern into the omission. Concern for global slowdown, trade, and “political uncertainties.”
Good theories well-argued, but something else is afoot, and as today’s data confirms, this economy is not fragile. It will take a while to be sure, but here is an alternate explanation for a stand-down Fed: December was the last ride of the runaway modelers so convinced that an overheated labor market or too-fast GDP growth would inevitably bring inflation. The Chauffeur himself has questioned these models, badly undercut by predictive failure for years. Add Powell’s mention of “muted” global inflation.
The Fed has defined for many decades the GDP speed limit as the sum of population (work force) gain and productivity increase, today both a little under 1% annualized, and therefore growth beyond 2% will be inflationary, and the Fed must force a slowdown. That equation has failed throughout this recovery, and some would say clear back to the 1990s and the new age of IT-trade-demographics suppressing inflation.
Wednesday’s statement: “The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near… 2% objective as the most likely outcomes.” Rapid expansion, hot labor, and tame inflation. That is anti-model. The Fed will stay worried about a wage spurt, but the crime scene suggests that the GDP speed limit has been murdered. The Fed expects GDP growth to fall from 3%-plus to something in the twos, but nothing like their published long-term limit near 1.9%.
Another equation discovered dead in the front hall this morning: job growth must slow below 100,000 per month, or else.
The evidence supports a correction in the Fed’s public statements, but extended patience requires something else: in today’s economy overheating by growth alone is not a hazard if without outsize wage growth or the fact of rising inflation. We are at risk to accidents and dumb things at home and abroad, but no longer to unnecessary Fed tightening.
Larry Kudlow, previously comedy host on CNBC and now Director of the National Economic Council in the White House has for forty years claimed that “growth does not cause inflation.” He has at last lived long enough to be correct. And if the outside world stays in its mire, and the combination of IT, trade, and demographics continues to stifle inflation, he may be right for a long time.
The 10-year T-note is trading 2.68% today, the good economic news forcing a minor adjustment upwards after Fed Halleluiahs! on Wednesday. 10s could stay between 2.60% and 3.00% for a long time. Chart is 10 years back:
The Atlanta Fed GDP tracker will look backwards until the Census Bureau reopens enough to produce the first formal statement for Q4 2018. Then Atlanta will begin to estimate Q1 2019. Many observers had thought Q4 would be weaker than this chart, perhaps 2.0% but today’s data is too hot:
Cautionary in several ways: the ECRI, among brightest of the bright now speaks of a “recessionary window” above this ugly chart. Among the cautions, don’t believe everything you think. The ECRI seems spooked by the extended Fed hikes and flat yield curve: