“Clueless in Washington” or, better no theory than bad theory

What has changed with the move from Yellen to Powell? From yesterday´s presser, less reliance on theory and models and more weight on the actual behavior of the economy.

For example, Powell said that labor market getting tight when we do see more meaningful upward move in wages.

According to the chart below, that´s “far off”. The blue line indicates wage growth when unemployment is “low” (below 5%).

Implicitly, he dismisses Yellen´s preferred theory. To Powell, “The theory would be if you get below the sustainable rate of unemployment for a sustained period, you would see an acceleration of inflation. We are very alert to it. But it’s not something we observe at the present.”

Maybe never! With the chart showing inflation remains low with unemployment falling below 5%.

When answering a question about yield curve inversion, Powell shows lack of knowledge stating that happened only when inflation was “out of control” and the Fed had to tighten forcefully.

The chart shows that yield curve inversion preceded the “low inflation” recessions.

Powell also shows he doesn´t take seriously longer-term forecasts.

When asked about the risks of a Fed Funds rate above 3% two years from now, he answers: “that far off, too uncertain to merit attention”.

Asked whether tax cuts will deliver supply-side benefits, he concluded, “the whole thing is very uncertain.”

Growth projections have gone up and unemployment forecasts have come down, with growth being above their estimate of potential and unemployment below their estimate of the natural rate.

Inflation projections haven´t changed significantly. To show that they are cavalier about inflation going above 2%, for the first time they project “next year´s” inflation to be all of 2.1%!

Bottom Line: Powell is optimistic for reasons he cannot really explain. Nevertheless, he´s committed to hiking rates between now and 2020, which puts FOMC decisions on “autopilot”. That´s not a good omen.


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