We got our first read on Q3 2018 NGDP last week, it came in at $20.659 trillion, right in line with our model’s number of $20.684 trillion, based simply on the model’s time series ‘momentum’ of the recent NGDP component and the market prices component. Recent NGDP movements are the best predictor of future NGPD movements, even more so than market signals; so often NGDP updates can move our forecast quite a bit, but not this time. Instead, the forecast has dropped due to…you guessed it…the huge drop in US equity prices, commodities, a bearish shift in the yield curve and a stronger dollar.
As a sanity check on all the market turmoil we have seen, we can look at TIPS spreads (also in the model). The 5-year TIPS spread has fallen from around 2.04% in the first week of October, to 1.91% as of October 30, the lowest level since March. With such a broad array of asset prices down, including inflation expectations, there is only one way to read it: markets have downgraded their NGDP outlook, i.e., monetary policy is tighter.
What has caused this drop? Who else but the Fed, the only party who can be said to control monetary policy. In this instance, we would point out that the market drawdown seemed to advance after President Trump began commenting on Fed Chairman Powell, saying Powell’s rate hikes were the biggest challenge the President faced. I am not aware of a way to robustly test this, but it seems that the Fed boss, with a multi-year appointment, might be inclined to turn the screws on an annoying president who crosses such lines. Maybe the markets anticipated this, who knows?
Regardless of the origin of the drop, our NGDP forecast has plummeted to around 4.3% for 2019Q4, from around 4.7% at the start of the current vintage. This drop is almost entirely due to market signals rather than an NGDP ‘surprise’ in the new data. One is tempted to call this pace of growth “non-credible”, given what we have seen out of the Powell Fed, particularly in light of TIPS spreads.
Whether one chooses to call the Fed’s bluff here and go long is a call, we, as Efficient Markets Fundamentalists, must leave up to the individual. Recessions and growth slumps do happen, even though they need not. The current market footing suggests 2019 will be a lot less thrilling than 2018 was; let us hope things turn around.