“Winds of War”

Week Ending Friday March 2

This was a relatively rough week for markets. The S&P 500 fell 1.8%, Friday-to-Friday, most of this seemingly linked to statements by new Fed Chairman Jerome Powell, as well as a tariff announced by the Trump administration on steel and aluminum.

Powell’s statements were less polished than Bernanke´s or Yellen’s, though equally platitude-laden and low-information. Powell says inflation will return to 2% in some unspecified but near timeframe, with no indication that a period of offsetting 2%+ inflation would be allowed for symmetry. In other words, the 2% PCE inflation ceiling remains in place.

Powell repeatedly referenced the analogy of an “overheated” economy, as though the network of transaction and production decisions we call the economy were a Victorian steam engine. One wonders if the economy can “melt” after it has “overheated” and what this would look like in a brass-tacks sense.

Presumably, the tiles on the super market floor will smoke and the rubber will ooze off electric power lines as the economy “overheats”. Markets were probably more disappointed by what Powell didn’t say (allowing catch up inflation) than what he said. More of the same, no new thinking at the Fed.

The Trump tariffs are not particularly significant in and of themselves. Steel and aluminum are certainly important industrial inputs, but the effect of the relatively modest tariff rates would likely be trivial on the US aggregate supply potential. Markets were likely spooked, instead, by the prospect of future tariffs, and the potential that the tariffs spark a “trade war”, wherein tit-for-tat duties and import ceilings result in a morass of complex new trade limitations.

Data

We hoped to see NGDP revised upward in the new GDP estimate released last week; sadly the number for Q4 remained essentially unchanged. It still looks like NGDP will come in around 4.4% over the next year, which is high enough to cause a modest uptick in many measures of real economic activity, as well as corporate profits, but not exactly a thrilling pace. There is one more chance, late this month, to see an NGDP-driven change in the forecast, when the third GDP print is released, along with the first GDI print. Our forecast system treats GDP and GDI as equally valid measures of nominal spending/income, so the upcoming third release gives us a more authoritative view of NGDP momentum.

The GDP data were not especially interesting, though we did get the Disposable Personal Income reading for January. Disposable Personal Income rose 0.9% month over month, the biggest increase since 2012.

Monthly data are however especially noisy, and January would have been when the tax cuts kicked in. Fiscal shenanigans such as tax cuts can move data in the short term, but for our purposes, looking for what will happen in one year and further ahead, we are after clues as to the economy’s inflation-response to a change in the NGDP trend.

The personal income data are an early sign that the tax cuts were stimulative, but the Fed wears the pants; will they offset the resulting rise in spending? Alternatively, will they lose heart if/when inflation breaks 2% year-over year? Smart money would say they lose heart, and this is essentially what Powell is telling us too.

Other data this week included New Orders for durable goods, the year-over-year rate of which fell vs last month, but is still conveying an upward trend. The Existing Home Sales series was updated and showed a marked drop, though the Atlanta Fed’s GDP Now forecast rose on the week, now at 3.5% annualized for real growth in the first quarter of 2018. The current standing of GDP Now is a strong result and a good summary of where the current-quarter data stand overall, given the strong out-of-sample predictive power of this indicator.

Inflation remained dormant, despite the 0.3% m-on-m print for the core index.

Next week will see Consumer Credit, the Trade Balance and jobs report updated in a relatively light data week. The main thing to focus on will instead be the markets, which may show marked reactions to more clarification on how President Trump intends to conduct his protectionist policies.

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