The Week Ending Friday May 18th 2018
What to make of the 10-year bond yields pushing over 3%. On the one hand, 300 bps is just an arbitrary number. Our NGDP Forecast is showing no sign of any dramatic shift in the rate of nominal growth. There has been a trend for us to show nominal growth around 4% instead of 3.5% for some time. Our NGDP Forecast takes in both recent trends in actual NGDP growth and a range of market indicators, not just 10-year bond yields. 30-year bond yields have not moved much. Oil prices have shifted up but copper and gold shifted down. Equities had hit records but have gone sideways for a while now. The USD has risen, usually a bad sign for growth.
So why the shift in those 10-year yields? Well, 5-year breakeven inflation yields have moved convincingly above 2% for the first time in six years. The data is showing some rise in the inflation measure preferred by the Fed. Both Core and Headline PCE Inflation has picked up YoY in March, to 1.9% and 2.0% respectively. Core CPI jumped up to 2.1% in March and stayed there in April. Only in two weeks’ time, right at the end of May, do we get the April PCE Inflation data.
Changing mix in NGDP on the way, less real, more inflation
If markets are right then there appears to be a shift in the mix of NGDP Growth towards more inflation and less real growth in the quarters ahead. Should this concern the Fed? It would seem that at current levels of employment and unemployment that the Fed would be happy to ignore a fall in real growth if it meant reducing the expected inflation rate below 2%. In this case, nominal growth rates will come under further pressure as a sign of continuing Fed tightening, indicated to others by the Fed projections and market expectations of three more rate rises this year.
Closing gaps in inflation expectations
Interestingly, confidence in the Fed winning its battle with inflation is provided by the shrinking gap between 5-year breakeven inflation expectations and 5-year 5-year forward inflation expectations (i.e. where 5-year inflation expectations will be in 5 years’ time). They show that for many years, the Fed was struggling to stoke near term inflation expectations, but markets thought that in five years inflation would be “back to normal”.
As near term expectations have risen, the market remains convinced the Fed will crush any further moves upwards, hence the gap between the two has closed to zero.
Actual information was OK
Data on Retail Sales and Industrial Production was actually reasonably positive with regard to YoY trends, even if nothing exciting at all over the longer term. There remains a problem, lack of real growth and especially lack of real growth per head.
This week will see little new news on the economy. At the end of the week after that we get to see the most interesting data on PCE Price Inflation for April – that in turn is likely to merely confirm the Fed rate rise in June and rate rises for the rest of the year. The Fed doesn’t seem to care if real growth slows or unemployment rises, in fact it seems as if it would welcome such negative trends.