November 24, 2023

 

Robert Brusca, PhD

Fact and Opinion Economics

(FAO Economics)

 

FAO economics is an economic research consulting firm that delves into the analysis of macroeconomic data and policy analysis.

 

There is a strong focus on central bank behavior and how the Federal Reserve makes policy announces it to the public and implements it.   

 

I am currently writing a substack at this address:

 

https://robertbrusca.substack.com/

 

 

BIO Summary:

 

ROBERT A. BRUSCA is Chief Economist of Fact and Opinion Economics, a consulting firm he founded in Manhattan.  He is also a past professor graduate program at the Zicklin School of Business at Baruch College in Manhattan. Mr Brusca has been an economist on Wall Street for 48 years. He has visited central banking and large institutional clients in over 30 countries in his career as an economist. Mr. Brusca was a Divisional Research Chief at the Federal Reserve Bank of NY (Chief of the International Financial markets Division), a Fed Watcher at Irving Trust and Chief Economist at Nikko Securities International (for 16 years). Mr Brusca currently is a consultant. He is operating the second of two consulting firms he has founded since 2001. He is widely quoted and appears in various media. Mr. Brusca holds an MA and PhD in economics from Michigan State University and a BA in Economics from the University of Michigan. His research pursues his strong interests in non aligned policy economics, investing, as well as international economics. FAO Economics’ research targets investors to assist them in making better investment decisions in stocks, bonds and in a variety of international assets. The company does not manage money and has no conflicts in giving economic advice. Mr Brusca, or his comments, appears in a wide variety of media outlets.

 

 

 

 

 

 

 

 

 

 

An October Surprise from Jobs

How much of it do we really believe?

 

Job growth in October ratcheted down gaining only 150,000 jobs after gaining nearly twice that much at 297,000 in September. The slowdown in private jobs was more severe as September's 246,000 gain turned into 99,000 in October.  Government sector jobs led the job growth parade in October. 

 

Markets reacted strongly to this news that job growth was weaker in October than September knowing that it meant that job growth was weaker in October than it was in September…  And although that's all we really know, people in markets jumped to many, many, other conclusions based on this report that seemed to fulfill their hopes and dreams...

 

A month ago, the headline gain was even stronger as it has been revised down in this report but at that time markets did not react strongly to it because they didn't completely believe it. Markets have continued to believe the economy is going to slow. Indeed, markets have been looking for the Fed to pivot almost from the moment the Fed began to hike rates. This month on news of weakness. markets are even more certain that they're right, more certain than they were last month when the numbers showed them that they were dead wrong, at least for a while - unequivocally wrong.  The Market view is undeterred.

 

Job growth in the economy has wrong-footed forecasters for quite some time… but that's not surprising after the tremendous amount of fiscal stimulus that had been poured into this economy on top of an enormous dose of monetary stimulus.  Stimulus is in the process of being unwound and certainly based on the current level of rates, and that level compared to inflation, monetary policy is no longer stimulative. However, monetary policy works with the lag and that works both after stimulus as well as after rate hiking and we can't be sure that all the effects of the monetary stimulus have been boiled out of the system yet. For example, in this report, construction jobs increased by 23,000, more than the 13,000 that were created in September, and greater than the three-month average of 22,000 per month, and greater than the year-over-year average of 18,000 per month. So, the spike in rates and the high mortgage rates themselves have not caused the construction sector to roll over. People looking at this report are saying that it's evidence that the interest rate hikes are working but when you look at the interest sensitive sectors that doesn't seem like a provable hypothesis.

 

The BLS tells us that part of the reason for the downward revision to job growth in September was because of the UAW strike and some misclassified workers. Since the UAW contract gives a raise of 11% in the first year and more to come later as auto production gets back to normal, we can expect to see a reduction in these headwinds. We've seen in the last several months while the strike was going on some pretty good job growth! Perhaps now there will even be stimulus from the greater income that workers will have in the wake of the new contract.

 

I'm not terribly excited to take this weak October job report and to run with it and call it the start of a slowdown in the economy. It may be that, but then again it may not because this is not the only game in town. Monthly job creation is a volatile thing; the 150,000 jobs come after a 297,000 job gain which had come after a 165,000-job gain. Over the last three months job creation averages 204,000 pretty similar to the 207,000 and average in the previous three months and this month's number of 150,000 isn't really all that much weaker than the average of 204,000 for me to jump up and down about it. 

 

However, in the job report there was also a reduction in hours worked. There was a rise in the unemployment rate and there was some ongoing moderation in wage gains. But as we look ahead, we have the UAW contract kicking in and its potential to be a bellwether for other wage gains in the economy. The unemployment rate has risen half a percentage point from its low and it's within 1/10 of a percentage point of triggering a recession warning according to some of the signaling mechanisms that I'm acquainted with.

 

It's true that there are several aspects of this report that point to things slowing down but again we'd like to see some trend rather than just one month's worth of data and particularly one month after a very strong month.  I urge vigilance and looking at the numbers and anticipating the future we need to make the numbers show us what's happening rather than to bet too much on anticipation because anticipation has been so wrong in the wake of the COVID recession. We continue to have cross currents in this economy and it's still true that while the federal funds rate is no longer at a stimulative level it's not at a very restrictive level either. So, when comes to braking the economy, I don't think that interest rates are providing much braking although we could be looking at the dissipation of the stimulus from monetary policy in the past as well as a tailing of fiscal policy. Be open-minded about the trends we're observing and about extrapolating them too far into future.  It’s been a tough time for forecasters.

 

 

 

 

 

Good fences make good neighbors

Except on our Southern border?

What would Robert Frost think?

 

What a fence does: Having a clear boundary between your house and your neighbor’s, and respecting that boundary, helps to keep the peace between neighbors, and thus good relations between neighbors are partly dependent on fences as a marker boundaries.  ‘Good fences make good neighbors’ pithily expresses the need to have clear boundaries between properties, as well as the need for neighbors to respect these boundaries, if relations between neighbors are to remain amicable and ‘good’.  Source

 

With that prelude I have never understood the Democrat’s opposition to Donald Trump's desire to have a wall on the southern border. It is quite clear that the southern border has been porous for some time and that people can get into the country without too much difficulty and beyond our control because the border are is so open and vast.  What's the point in having a border if the border doesn't mean anything?

Why don’t we rename the county: The United States and the Americas?

As a further point Democrats who belittled and berated Donald Trump for wanting to build a wall accusing him of racism, among other things, laid the groundwork for the belief by all people South of our border - or anywhere else - that if Democrats gained office the border would be open.  And so the incredible problems we have had with undocumented aliens coming in droves across the border into the country straining social services can only be put at the feet of Democrats. They wound up encouraging this because they were so eager to damn the policies of Donald Trump. Lesson be careful how you hate?

 

It's hard for me to understand why anybody in any political party would want to fail to define and defend the border. The US has such a problem with that southern border not just with undocumented aliens coming across but with drug smuggling it would seem that a more secure border would be an objective of any political party with a sensible view of geopolitics.

 

Mayor Adams in New York has called the migrant crisis in the city- the city in which I live – one that is very serious and the first time that he has seen a problem in his professional career that he's not sure has a solution or an end.  It is not surprising that border state governors have taken action to try to ship immigrants who come into their state to other states because these undocumented aliens create just as much strain on the Texas economy as they do on the New York economy or any other economy. And Democrats are the once who have strongly supported this porous border policy, so Democrat run states need to share the pain. Since Texas is on the border and since the federal government that is supposed to be guarding the border hasn't done that Texas has wound up bearing the brunt of the burden along with other border states.

 

It is often pointed out that allowing people to flood across the border and get in a queue for citizenship undermines other avenues for citizenship that have been in place far longer and that have required a thorough vetting of applicants who have had to wait many years for their applications to be considered and approved. Why do that?

 

This is another example of the Democrats creating a policy much like French foreign policy at the end of World War Two period. At that time the French were determined to be on their own and not necessarily to follow the United States. French foreign policy became the opposite of US foreign policy. Whatever US foreign policy objectives were the French objectives were the opposite. And this is precisely what the Democrats have done with Donald Trump. Whatever Donald Trump likes, whatever he endorses, whatever he supports, they are instantly against, without even thinking about it. And this border situation is the perfect example of how that kind of cancel-culture has gotten them into a great deal of trouble.

 

Joe Biden put the border problem in the hands of Kamala Harris who decided it was a toxic problem that it had no solution and she didn't want to be anywhere near it. And as far as I can tell nobody in the administration has done anything to try to deal with the issues that came to the border with the election of Joe Biden. The Democrats insistence that Donald trump's closed border policies were wrong led to this mess.

 

There are many examples of Trump supported policies that were subsequently blocked by Democrats or by medical experts during the COVID crisis. And while there's no sense that Donald Trump had any kind of magic touch it's also clear that he had a number of ideas and policies that never should have been dismissed out of hand the way they were. But this is the new world in which we live and in which Democrats have supported this culture of cancellation as well as an approach to assert that they know what is right and have implemented policy based upon their view of science even where science is in dispute.

 

Just a reminder here… science is much less in dispute than it is in flux. When policy needs to depend on some aspect of science that's in dispute, we need to have a better way to decide what we think the approach should be rather than have one party dictate and steamroll its own view into the future.  The Democrats bull on the China shop approach to the southern border problem should be enough to convince just about everyone that when it comes to dispute resolution, they don't have a clue, let alone the answer.

 

But we do have complaints from some politicians such as the mayor of New York City who are very concerned about how they are being overrun by immigrants and about the financial burdens being placed on their cities. We do not find the liberal press engaging in any criticism of the open border policy. Instead, if you want to consider the positives and negatives of Trump's wall all you need to do is go to this article on Vanity Fair (here).  I think you'll agree that the article displays a lot of vanity and little fairness. 

 

What to expect if you are expecting (low-inflation) but shouldn’t be

...and why you probably shouldn’t be

 

Economists put inflation expectations and term premium effects on treasury securities in different boxes when analyzing the yield curve but maybe they should not.  I have had a bit of a ‘running feud’ with Fed officials as I have been haggling with different visiting Federal Reserve officials when I have been able to catch them in New York and query them on Fed policy, real interest rates, and interest rate expectations. The Fed has only one position on these things and there is a reason for it. I am convinced the reason is not just because the Fed thinks it is right.

 

What is at issue here and now is that the yield curve is getting steeper without any explanation! The Fed asserts that term premia are rising (for some reason) but that inflation expectations are anchored- and not a reason for this. One conjecture is that the size of the federal deficits, political conflicts, the risk of a fiscal event, and huge slate of bonds to be auctioned are causing investors to seek greater premia on US treasuries.

 

As Peggy Lee once asked…is that all there is?  

 

Maybe not…

 

The Fed is conveniently leaving itself out of the picture (ignore that man behind the curtain…). And yet, the Fed has allowed inflation to flare, run high, and has only reluctantly chased it, and vigorously raised rates, then stopped suddenly, when interest rates reached the level of trailing inflation.  After letting inflation run hot, I do not recognize this Fed rate hiking effort as a strong anti-inflation move. The Fed wants to tout its string of 75bp rate hikes but those were essential for the Fed to catch up after it sat on its hands for a year doing nothing as inflation surged over its target.  To cut to the chase… I greatly suspect one of the reasons the yield curve’s term premia are rising is the loss of Fed credibility mixed in with perceptions of higher inflation risk because of that.  The Fed of course will not go there. My argument is below:

 

The Issues are…

When I have complained about Fed policy, I point out the real Fed funds rate in the past cycle was as deeply negative as it had even been. Sixteen of the twenty lowest real Fed funds rates since 1960 (exceptionally low negative values) occurred in this cycle. When confronted with this FACT Fed officials reject this argument since you need to compare the level of interest rates to expected inflation not actual inflation from the past- so they say. Really? Well, full points to the Fed on that academic argument. But how does that work in reality?  Answer: it does not work…  

Chart 1

 

The University of Michigan provides several series on CPI inflation expectations five years ahead.    There are two here, the mean and the median. The mean is higher so naturally the Fed usually refers to speak of the median. You can clearly see that inflation is much more volatile than inflation expectations here. The CPI’s variability is over two times as volatile as the mean and nearly four times more volatile than the U of M median. The Fed wants to argue now – and every Fed member who gives a speech these days - reports this bromide: ‘that inflation expectations are well anchored.’  But if you look at the history of these series, they seem to be perpetually anchored! Especially the median!  The chart here plots inflation expectations at the time they are formed not shifted against the period five-years ahead to which they apply.  But it’s obvious that these series do not predict future inflation well at all.

 

Now I am going to show you something that is shocking!

 

Chart 2

This chart plots the U of M mean inflation estimate Vs the actual CPI inflation rate at the time the U of M estimate is formed. The greatly improved fit is achieved by plotting inflation expectations as rankings against the CPI also plotted as a ranking over the same period.  What these charts help to reveal is that the level of inflation expected is not well correlated with the level of current or future inflation. But when ranked, expectations are higher when inflation is higher and with that an expectation-inflation link is established. 

 

What this demonstrates, in fact, is something that can be seen in chart 1 if you look closely, that inflation expectations are not anchored at all. Presented as rankings inflation expectations are exceptionally high- compared to the range of values that historically it has taken on.   People who form inflation expectations in this survey are affected by the current environment but are not willing to be very bold in making projections…that is the Achilles heel for the Fed.

 

To me this observation significantly blunts the usefulness of inflation expectations that the Fed relies on so much. In fact, it seems to me that it is more likely that we should conclude that investors really do not form inflation expectations in a formal sense the way theory assumes. Still, the ranking data strongly indicate they are aware and perceive inflation risk as higher or lower from time to time. Because of this I believe that it is likely that inflation risk becomes embedded in the yield curve as part of the term premium – it’s not a separate issue. That opens the door to saying that the yield curve is steepening because of a too-tepid monetary policy and perhaps also for various fiscal reasons.

 

The Fed will not go there. I will. I have made somewhat more detailed arguments on this topic in an article you can read on Seeking Alpha here.   The Fed’s unwillingness to take a reasonable position on the subject of real interest rates and its unwillingness to accept that it made real rates exceptionally low in the post Covid period, is just a way for it to try to avoid the blame for what is happening.  

 

But what is worse is that the ranking data confirm my suspicion that whether they are good or not, inflation expectations, in fact, are formed. And they are not good because they do not anticipate future inflation well. But the relative rise in expectations is clear and demonstrates that investors inflation hackles are raised.   That means they may in fact be marking up inflation risk much more than the Fed thinks. That maybe part of what the yield curve is telling you…

 

You can accept or reject this argument. I put it on the table. And I think the Fed’s approach of refusing to look at the traditional real Fed funds rate measures that have been a reliable gauge of the tightness of monetary policy historically is a real mistake. We are witnessing a Fed that is being extraordinarily influenced by politics. I am quite concerned that the Fed will not talk about policy and what it has done in an even-handed way.  The Fed’s fingerprints are all over this inflation rate and now it is hoping that inflation continues to ratchet down.  I think the inflation deceleration period is about to slow dramatically. That will then put the Fed in a more difficult spot with elections coming. How long can the Fed continue to pretend a soft landing lies ahead? Maybe we should take bets on that…

Fed should hug you with alligator arms

Schematic of Fed policy

Fed Schematic (1) How the Fed thinks the world works

Unemployment    Labor

   Rate      ---à    marketà Wages -à Prices à Fed Funds -à ActivityàPrices

Fed Schematic (2) How Policy Works in this world

Unemployment        

Rate -à Labor Market    -à Wages-à Pricesà   Fed Funds

                                                  DIMINISHED  

                                        IMPACT ON WAGES and PRICES                                               

Schematic (3)  How the Fed/economy has really been working                                                                                                     

                                                                                                  

Unemployment        

Rate -à             ???        -à Wages-à Pricesà   Fed Funds

                  Fed skips wait for pass-through, assumes it and hikes Fed Funds

                                    on the basis of a low U3-rate alone

Since the Fed believes that the world works one way {Schematic (1)} it makes policy on that belief.

Seeing the unemployment rate so low, the Fed assumes that the process is underway and DOES NOT WAIT to see inflation emerge before it hikes rates Schematic (2). But we have a PROLIFERATION of information that question whether that transitional process is really still operative, Schematic (3).

Problems

Evidence suggests that the unemployment rate is not the same variable it used to be…

Participation rate changes show some of the labor force characteristics are changing

As the labor force ages its characteristics change’ productivity changes, many aspects change

Not surprisingly…

There has been a big shift. The participation rate has come to explain the bulk of the shift in the unemployment rate. This did not used to be the case (see below). This shift should cause us to wonder the nature of unemployment rate itself. If shifting demographics rather than rising employment or falling unemployment is the main determinate of the rate of unemployment, hasn’t the nature of that rate changed? It is a question the Fed seems to entertain in policy discussions and in speeches BUT NOT in the application of policy itself.   That’s odd.   

In addition there have been non-demographic shocks as people, not just those in the upper age cohorts, have reduced their willingness to participate in the labor force as either employed or unemployed persons. The U6 rate is more inclusive as it encompasses a broader view of what people are jobless. 

While the unemployment rate (U3) has fallen, the U6 rate has not fallen nearly as much. The charts (above and below) show very different views of the world. The U3 rate is rarely lower and so the Fed fears (AKA is ‘sure’) that schematic number one is in play. It is ready to act as in schematic number 2 to jump interest rates on the reality of a low U3 rate fearing inflation is coming… But the unemployment rate ratio of U6 to U3 shows us that the U6 rate has not fallen nearly as much.  It reminds us that by a different measure there is a lot more slack in the economy than U3 suggests. By that I do not just mean that the U6 is higher. It is both absolutely and relatively higher. The ratio is higher. And that is significant. If there is more slack a lower U3 rate might not create so much wage pressure. Anticipatory rate hikes might be ill conceived.

U3 is rarely lower. And the Fed is worried that such a low unemployment rate implies with NEAR CERTAINTY inflation is on the way. So the Fed is taking the OPPORTUNITY of growth that it sees as being more stable and reliable to HIKE interest rates from super low levels. Still the chart above also informs us of another interesting peculiarity. In the Post-War period when the U3 rate has been this low a recession has been ‘just around the corner.’ In fact recessions have occurred from much higher levels of unemployment than what we have today. On average since 1950, recession has occurred with about 2 ½ years of the Unemployment rate (U3) first breaking the 4.8% mark. But lead times have been as short as two months and as long as nearly five years. So there is the question of if the Fed thinks that the old U3 rate is just the same old thing or not? Does this explain why the Fed is hiking rates? Is it because it fears a recession is around the corner and the Fed feels a need to get rates higher? Does it really fear inflation? …Inflation that is not really developing? What is the Fed’s real rationale for what it is doing? I get the sense that the Fed is running words past us that derive from an old paradigm that no longer works and is not relevant.

How we should measure the unemployment rate has become a controversial subject, but we also know that what the unemployment rate DOES has shifted. In short the Fed’s policy of leap-frogging the impact of the low unemployment rate to head off inflation (that may not be in train) is a policy tact without strong rationale anymore. For an institution with more economists than you can shake a stick at this is a brazen disregard of some basic economic facts. Let’s look at some. 

More Problems: Stylized facts about the unemployment rate…

The main relationship that maps the unemployment rate and its changes into inflation works through wages and is called the Phillips curve. But the Phillips Curve relationship has become flat. It has shifted down and it does not depict a very POWERFUL relationship between unemployment and inflation. It certainly does not begin to explain why the Fed is so dogmatically out of sorts about the low rate of unemployment.     On the chart above the unemployment rate can fall from 7% to 4% and wage rate inflation will rise from about 2% to about 2.7%. However, the lowest unemployment rate we have seen since 1950 is 2.5%.... a rate that low would result in a drop in the unemployment rate by only another 2.3 percentage points, and some modest additional wage pressure. Is that what the Fed fears?

In addition, other relationships have shifted. Here we see that there is still a relationship to wages through a heightened quit rate but that that relationship is also is less powerful. It has shifted downward and the slope depicting the impact of change in the quit rate on the change in wage inflation is diminished as well (the slope of the line is flatter). Market power has shifted away from the worker even when the job market tightens. Firms are reluctant to raise wages because of international competition and are further empowered to hold back wages hikes because technology has given them more options. Note that we get these muted relationships even though, in recent years, government legislation has had a role in pushing wages up though increases in the minimum wage rate as the unemployment rate fell.  Those hikes are still in progress.

Moreover the ‘trigger’ for inflation creation in this model is a dropping unemployment rate and the chart above shows that the pace of the unemployment rate drop has slowed to crawl and we might even wonder if it is still in train…

Conclusions, observations and a policy recommendations

In the 1980s when inflation was high the Fed adopted a monetary approach to monitoring inflation and to setting monetary policy. In the early 1980s Fed policy tightness rose and fell on things like money supply and bank reserves. Under Alan Greenspan the Fed lost its theoretical focus and began heuristically to follow his mantra which was that inflation should be as low and close to zero as is practically possible. Under Ben Bernanke the Fed drifted on the same path for a short while until Bernanke got the Fed to adopt inflation targeting on the heels of the same approach used by the ECB and the BOE. This policy, which like Greenspan’s method, is output oriented (targeting inflation itself) rather than input oriented (aimed at controlling the money supply and bank reserves that create inflation). Inflation targeting is also meant to corral the benefits of focusing expectations on the target. If the central bank has credibility and demonstrates that it hits its inflation target, the more likely it is that the transactors in the economy will build that expectation into what they are doing so that the target becomes more robust and more easily achievable.  

Leader as follower- Janet Yellen’s recent speech (March 3, 2017) began on the note the Fed likes to reinforce which is that the Fed is merely following the mandate laid down by Congress. But in fact the Fed has a great deal of flexibility in how it achieves its dual mandate for price stabilization and sustaining low unemployment. The Fed has chosen to use inflation targeting and to adopt all the layers of communication problems that resulted when it chose to implement Congress’ directives by dabbling with the notion of employing policy guidance.

Fed policy makes more sense than the rationale for Fed policy…The Fed insists on a policy paradigm that focuses on its ability to achieve its unemployment rate and inflation objectives. These are two goals that often find themselves in opposition. For now the Fed is in the position of having both metrics reasonably close to their goals. For the moment the Fed acts as if the unemployment rate can’t fall much further (or that it shouldn’t) and that inflation is still not quite high enough, but is almost (…and soon will be). However, all that is a lot of hair-splitting. The ongoing bump up for inflation is oil-price-related which the Fed has told us it usually tries to ‘look through’ (as the ECB is doing). Core inflation is really not rising. And the unemployment objective is for a rate that is flawed and of unknown merit as we document above. Core inflation shows little pressure and is a bit farther below its target of 2% than the headline (which is at 1.9%). But in economics given leads and lags and other variabilities one has to conclude that inflation is reasonably close to target. YES… it is technically below target and has been below target for many, many, months (57, but who’s counting?). Still, policy is really close to being in its ‘sweet spot. Policymaking is about looking ahead even if one does not drink the Fed’s Kool Aid on its need to forecast ahead. By looking at the position of the economy in the business cycle and at the level of the rate of unemployment, the Fed can make assessments of trends and of economic needs and decide on the fine tuning of making policy.  So what should the Fed be doing?

What Janet Yellen should do for her winter vacation: change the way she operates: The Fed should be focusing less on the hairsplitting notion of getting inflation back to 2% and on getting each of its variables precisely on target and focus more on having policy get rates back into a configuration that looks more like normalcy. Since growth is simply not going to get as strong as it used to, GDP growth around 2% is now good-to-normal. The Fed should be less concerned about whether the labor market is going to tighten, raise wages and boost inflation and instead be more focused on the fact that its main policy variables - even with all their issues- are relatively close to where they ‘should’ be and declare victory so policy can carefully -CAREFULLY- nudge the Fed funds rate back toward normal. The Fed in displaying the DOTS should focus MORE on a POLICY corridor from the dots than on the median or average of the dots (trimmed or otherwise). I know many will read this and say but that is what they are doing. Yes, it is sort of…. But this is not the justification that the Fed is using and the policy approach is important. The Fed has to step out of the particular partition of the Japanese lunchbox of policy options it has set for itself and look at the whole lunch. If it were to do this it could free itself of the straight jacket of the language it has adopted and actually have the flexibility to implement policy within essentially the same framework. Right now policy is too myopic, too literal, too mechanistic and too technically oriented on policy parameters of unknown quality. The Fed needs to stop pretending that the job market, the unemployment rate and the Phillips curve are a good way to run policy. They certainly are not. And the sooner that the Fed jumps off that band wagon the better.

It’s not brain surgery...it’s about alligator arms (or, more simply, STOP Over-reaching!)

The Fed needs to use a blunter pencil when assessing its own performance. If we knew that

(1) 2% were exactly the right inflation rate,

(2) the PCE were the exact right inflation gauge,

(3) the U3 rate were the right unemployment rate and

(4) where the proper U3 level stood,

then, policy would be (somewhat) easier to conduct.

But in fact we know none of these things - NONE. That’s why I think that Fed should declare victory and move on to focus on the right path or speed for getting the Fed funds rate back to (or toward) normal without destabilizing growth. That, right now, is the key policy problem not whether the core PCE is going to climb three tenths of a percentage point in the next two years….really! The Fed has been framing this as a question of where r-star is. And in reality r-star (r*) is in the Fed’s spot light more than the Fed’s two policy ‘targets.’ R-star is the interest rate (natural rate of interest) that is neutral or stable-growth-low-inflation-preserving at full resource utilization. Thus the question now is not whether inflation is exactly at 2% but if there is some reasonable expectation, not a real true forecast, but a reasonable expectation that it will rise there by 20XX as growth progresses accordingly.  Obviously since inflation is ‘bit lean now’ the Fed could allow a slightly faster growth rate and do this by keeping (r_t

END     

7 Pitfalls For Donald Trump

The order of policy implementation matters...Trump will get it wrong.

Trade tariffs and competitiveness- The reason NAFTA fails and China obstructs  

Tax-cut stimulus to be haunted by the 47%...remember them?

Infrastructure stimulus: loved but lacking

Success depends on whether it’s a ‘U-6’ or a ‘U-3’ world

Reality bytes – tech remains a problem for jobs

Demographics, trade, and the 47% stalk the multipliers

See full article at link below

http://seekingalpha.com/article/4025070-7-pitfalls-donald-trump

Fed rate hikes matter

Fed rate hikes matter

There are two extreme schools of thought on the Fed. One is that because of the size of its balance sheet it controls everything: the level of interest, the yield curve, all of it. Another view is that the Fed does not matter because the market still can poke through the veil of secrecy and get rates where it wants them. If the Fed has a different view from the market and it lower rates too much the market will steepen the yield curve. If the Fed over tightens, the yield curve inverts to compensate.

Reality- Between these two extremes there is the reality which I believe is that the Fed sets the short rate and influences the long rates – how much influence remains a matter of debate. But I do not think that the Fed pegs all rates yet it does disrupt many of them in a way that may render the yield curve and the rate spreads as much less useful barometers on the markets and on the economy compared to more ‘normal’ times. Markets can be fooled by what the Fed does and says and markets can be misled as well.  

Mystifying monetary policy- With the economy fragile, growing slowly, productivity weak, inflation still undershooting and the outlook uncertain, it would not be a good time for the Fed to mystify markets but that is what it seems to be headed for.

The WSJ view as an example of what is wrong- A recent WSJ article (here) just jumbled together the ideas of the Fed guiding markets, communicating clearly, and having made up its mind about December while fluffing past the notion of the Fed being data-dependent. 

Two schools on the Fed- Interestingly a number of Fed critics think that the Fed is doing the economy a disservice by keeping rates so low. Another group fears that the Fed is ready hike them too soon or too quickly or by too-much altogether. I am in that latter group.   

The 2015 paradigm- In my view, the Fed got itself into trouble in 2016 by what it did at the end of 2015- hiking rates prematurely.  Amid great fanfare, calling the period of special accommodation over, the Fed raised rates in December about 10-months ago even though its own stipulations for a rate hike had not been met. But since many (all!) Fed officials had said at one time or another last year that they expected to raise rates in 2015, the Fed felt obligated to do just that – even though to do it required that the Fed violate its own rules. To accommodate and justify that rate hike that the Fed claimed to make policy based on its view of the intermediate term and where it ‘deemed’ growth, inflation rates and unemployment were going. That is how, with oil prices in the midst of spiraling lower and lower, the Fed was still able to move to hike rates in December of 2015. That is something that will always look like a really foolish mystery to future Fed historians. How could the Fed think it was on path to meet its inflation objective with oil prices in near freefall?  

The 2016 question: Now what is the Fed going to use to justify a rate hike in December 2016? It will pass on a rate hike in November because of the elections but will state a different reason. That is allowable central bank misdirection. But (a) with growth still weak, (b) inflation under shooting - (c) not accelerating- and with (d) the unemployment rate having stopped its relentless move lower and (e) having backed up from its lows, what will be the Fed’s excuse/reason for hiking rates this time?  

And why does it make a difference?

Why rate hikes make a difference

International fragility and feedback- While the Fed has from time to time talked about the importance of the international economy and on two occasions in the past year actually swerved policy (allegedly) for international reasons, the Fed’s expressed view of the importance of the international economy misses the point. The point is not that international turbulence should stay the Fed’s hand (Sept of 2015 and early 2016). Nor is the point that Brexit was a risk and a reason for policy to hit the pause button. Not that I am not arguing that those decisions were wrong, just that they miss the point. Yellen has talked of how monetary policies are more connected in some way which is curious because under floating rates monetary policies are supposed to be more independent. But that is getting somewhat closer to the point.  

Structure, impact and policy diffusion- There are several aspects on internationalization that the Fed seems to almost completely ignore. The first (1) is the way in which trade already had changed the structure of the U.S. economy and made it more vulnerable. The strong dollar already makes it hard for the U.S. to produce anything at home for export or even in competition with imports. Technology should be an equal opportunity disruptor but it has disrupted the U.S. more because of its high wages and uncompetitive exchange rate. A Fed rate hike (2) will make all that worse by moving the dollar higher, making it even less competitive. But that is not all it will do, (3) a stronger dollar will drive up the foreign currency cost of all commodities, oil included, and that puts downward pressure on dollar prices. A strong dollar will spread the U.S. rate hike globally; it is globally deflationary at a time that other central banks are trying to jump start inflation. Is that a good idea?  In summary, I am concerned not so much about the Fed hiking rates and about that impact on the US economy as I am concerned about the feedback effects in the international community

And it is  NEVER about just one 25bp rate hike-. However, do not dismiss the prospect of a Fed rate hikes as unimportant at home. Many have asked, “what’s the trouble with one 25bp rate hike?” Well that was December 2015 and you tell me, “what followed?” It was one 25bp rate hike… followed by chaos. Some of that chaos was Fed-generated as Stanley Fischer came forth with his great theory of why the markets were wrong and what the Fed would really do. Stanley will still be eating crow for Thanksgiving this year (…with a wonderful dessert of humble pie) he has so much stocked in his refrigerator after that dead wrong analysis- road-kill crow.

Fed fears make for bad policy moves- And that is just another reason why we should be wary of Fed policy pronouncements or forward guidance: the Fed simply is making it up as it goes along. It has little wisdom to impart, and worse, members have an agenda. They now fear anything from inflation to bubbles. They are not sure which is worse but they are sure that this will end badly and that there is something to fear and nothing like slamming policy into reverse to fix it.  

Not Ptolemy Copernicus or Kepler: the Big Bang radiates! -  Rates are important. Interest rates sit at the center of the international economy’s perceptions. They impact exchange rates. They are links to current and future consumption and investment. They have a role is setting inflation expectations. This is the last place that the Fed needs to be spreading mischief. If it is appropriate for the U.S. to raise rates it should be sure – very sure- because there will be repercussions of a significant nature from abroad, too. Last year’s hike should have made that clear. But I get the sense that the Fed has not learned much from that episode and instead treats it like a one-off event instead of like the endogenous response to the Fed’s own actions that it was.   

A mind is a terrible thing to waste…a waist is a terrible thing to mind…In short I fear that the Fed has grown and learned very little. It still seems to regard its new tool box as adequate, or it is willing to act as though it does. It seems to be willing to be bold with policy and inventive with its forecasts despite the economy’s circumstances and its past lack of forecast ‘suck-cess.’ In the guise of lifting rates to get away from the zero bound threat the Fed is flirting with that very problem and may force us to deal with it very soon instead of just to think about it hypothetically. Rate hikes are important because they are dangerous. Play with fire at your own risk. Ask yourself this…if there were no Fed what would the markets be doing with rates in this environment?  I don’t think that marching higher is a likely result. Do you?         

General central banking rules-  

My bottom line is that the central bank should have reasons for what it does. It should make these reasons known and be true to them. If it expresses a model or point of view its policy enactments need to be consistent with that view. Central bank policy should not cram the square peg of policy change into the round hole of what I said I’d do. Policy should be easy to understand and should not take much hairsplitting to explain why the bank acted as it did. Policies should flow freely out of the central bank’s policy ‘map’. No right hand turns from the left hand lane.