Week ending Friday 26th August 2016
Markets had a largely directionless week until Friday and the big Jackson Hole symposium. New home sales had excited the market on Monday but by Wednesday pending home sales had heavily disappointed as had the many current month surveys.
Triumph of hope over experience
Hopes had been raised the week before by John Williams’ Economic Letter proposing some new thinking but then quickly dashed by William Dudley in an interview and by John Williams himself in a speech.
Markets seemed to have picked up the vibe that nothing big would come from Jackson Hole and they were mostly right. In fact, the agenda turned out really boring. We had hoped last week that the FOMC minutes from July that said staffers would “evaluate potential long-run frameworks for monetary policy implementation” meant that they were moving on from “normalization”, implying that fresh policy thinking would emerge. It turned out to be just very old hat thinking about the nuts and bolts of policy implementation rather than “frameworks”. Oh well, another opportunity missed.
Set piece from Yellen was nicely balanced, i.e. it said nothing – probably
Yellen’s speech was the usual “on the one hand this, on the other that” with some interpreting a more hawkish stance on rates offset by some promise to work with any new fiscal initiatives that the executive branch might propose. The markets decided on balance that it was slightly positive with the USD falling and equities rising. She did give a very modest nod to fresh monetary policy thinking but only a very small one, and it certainly wasn’t on the official agenda for this year’s Jackson Hole.
“On the monetary policy side, future policymakers might choose to consider some additional tools that have been employed by other central banks, though adding them to our toolkit would require a very careful weighing of costs and benefits and, in some cases, could require legislation. For example, future policymakers may wish to explore the possibility of purchasing a broader range of assets. Beyond that, some observers have suggested raising the FOMC’s 2 percent inflation objective or implementing policy through alternative monetary policy frameworks, such as price-level or nominal GDP targeting. I should stress, however, that the FOMC is not actively considering these additional tools and policy frameworks, although they are important subjects for research.”
Maybe something is going on the deep in the background, as indicated by John Williams earlier, but it is only a very slim “maybe” at the moment. It may be that this analysis is being prepared in case the economy slows and the Fed needs to do more monetary easing without more QE and especially without negative rates to which it seems extremely hostile.
Fischer causes mayhem, again
About an hour after her speech the accident-prone Stanley Fischer dumped on the very modestly good vibes with a knowingly hawkish response to a question about the likelihood of two rate rises by the end of the year. He knew what the impact of his answer would be and couldn’t resist giving it. He is incredible, almost devious, given he called recent RGDP growth “mediocre” in a speech just a few days earlier.
The markets turned tail abruptly and the USD strengthened while equities gave back all their gains and more and the yield curve flattened. The curve flattened so much that the 10yr-2yr spread went back to below 80bps again. A bad sign. The chances of a rate rise in September jumped from 80-20 against to 66-33, and by December from 50-50 to 40-60 in favour. The market may have moved to one rate rise, but only by July 2017 as the market also reckons it will cause so much damage to be on the front foot of monetary tightening that the longer end budged so little.
The USD strengthened so much at the end of the week that Fischer had managed to achieve what Dudley and Williams’ backtracking from Williams’ Economic Letter had not done, bringing the USD index back to the middle of its medium term range.
Short-term rate rises would lead to medium term rate falls
The two year yields rose so strongly they reached 0.85%, levels not seen since the great May rebellion of hawkish FOMC members against market scepticism over the number of rate rises.
Negative market reaction to that protest and then the Brexit shock had led the market to expect no rate rises this year. As we said the 10-2 spread hit new lows as longer bond yields did not rally anything like as much as the short end, reflecting market caution about the impact of a rate rise and the active monetary tightening that it implies – especially versus weak economic data and surveys, especially current surveys.
Later in the day Bullard did pop up and reiterate his strong view of just one rate rise in the next two and half years. Sadly, he may just be side lining himself with his outspokenness, like Kocherlakota before him. We hope not, though.
What is going on?
Trying to put myself in the mind of the average FOMC member I come up with this logic, although it is not logical – perhaps because it reflects so many competing views and not just one human brain:
- The Fed wants to raise rates to give it the room to cut them when the data worsens – even though we know the data will worsen due to the raising of rates.
- The Fed really doesn’t want to:
- use negative rates because the banks, insurance companies, money market mutual funds and savers will complain very loudly; or,
- do more/wider QE because too many politicians, internet Austrians/goldbugs, alt-right, progressives, socialists, etc. will all complain about the Fed creating winners and losers “and may require legislation” as Yellen said.
- While the Fed needs rate-cutting firepower it is unlikely to raise rates before the data goes really bad, so it will need to look at more innovative alternatives than negative rates or more/wider QE, thus it is tentatively looking at a higher inflation target or even level targets for inflation or nominal growth instead as a sort of last resort back-up plan.
Current month growth looking poor …
The survey data for August continued to come in weak to very weak. It’s only surveys and only one month. Sure. But they are all part of a very weak trend in NGDP and a very weak run of RGDP readings. We commented on it in Data Watch . The weakness in the Markit flash PMI for the huge services sector was notable for its weak reading as it is a national survey.
Confirming the poor trend of August data were results on the weak side from the bi-weekly U Mich surveys of consumer expectations and sentiment.
… just like 2Q 2016
Amidst the noise from the FOMC on Friday the 2Q 2016 2nd estimate for RGDP was revised slightly lower. More interestingly, the estimate for Real GDI that is only released with the 2nd estimate for GDP came in barely up QoQ at just 0.2% vs RGDP at a sluggish 1.2%. It became very fashionable to prefer Real GDI when RGDP wasn’t as strong as the Fed and government officials had expected. YoY it has been running a bit below RGDP for a few quarters and so it had grabbed my attention. The YoY rates were equal at 1.2% at 2Q but it is a data line worth watching. Back in 2007 it was a canary in the coal mine” warning of seriously waning economic growth, but today it is ignored as it doesn’t fit the Fed mantra of “nearing its goals”.
RGDP 3Q nowcasts imply poor YoY trends for RGDP and NGDP
Atlanta Fed nowcast dipped to 3.4% QoQ annualized growth thanks to those poor pending home sales data. It is trending back down to meet the N Y Fed, that also fell slightly, at 2.8%. However, it is very early days in the quarter as we haven’t got the full set of July data and only these bad surveys for August. Taking the average of the two nowcasts for 3Q 2016 QoQ annualized growth would mean just 1.5% YoY growth for US RGDP in 3Q, another “mediocre” result for Fischer to chew upon – and imply about 2.6% NGDP growth YoY, another awful result.
These dull trends are no surprise despite US Base money rising slightly on the week. The YoY growth dropped back to the bottom of the year’s range at -5.8%.
August payrolls up next, crucial as highlighted by most FOMC members at JH
Next week we get the broader view of spending from the July Personal Consumption Expenditure data. Spending has been running faster than income for several months, despite claims of higher wage growth. So it will be an interesting read. The PCE PI will most likely continue dull. August payrolls at the end of the week will be the really big event given that the hawks on the FOMC seem to be campaigning so strongly for two rate rises by the end of the year. Perhaps Hillary Clinton’s strong lead in the polls will make the brave enough come the September meeting to act before the election.