Durable goods orders, ex-transportation, showed a negative print today for the second time in a row. This was expected, in most senses of the word, but while I don’t put too much weight on short-term wiggles in Durables it is hard to ignore the fact that the year/year change in Durables has now been negative for more than a year (see chart, source Bloomberg).
So the weakness in Durables is not new. But it bears noting that the last time core Durables went negative, in August 2012, the Fed followed with QE3 almost immediately. To be sure, at the time core inflation was all the way down at 1.9%, whereas today it is a heady 2.2%…
Look, any Fed watcher right now is and should be confused. Conditions which provoked QE just four years ago are now apparently spurring a tightening bias. Bill Gross can be excused for thinking that the Fed will go back to the old playbook and employ new QE, as he apparently did in his latest Investment Outlook – it is harder to excuse his saying that the Fed should drop money, given that it hasn’t worked yet.
But clearly, something is different in the way the central bank is approaching monetary policy. After all, nothing about this weakness is new. As noted, Durables have been negative on a year-over-year basis for a full year, and the Citi Economic Surprise index shows that economists have managed to be surprised on the negative side for an unprecedented fifteen months in a row (see chart, source Bloomberg).
Okay, the index technically turned positive once or twice for a day or two, but this is still the longest run of persistently optimistic errors that economists have had in a very long time. So this isn’t new – the economy is weak.
Unless…unless what is different is that in 2012, economists were pessimistic (the Citi Economic Surprise index turned positive right before the Fed started QE, which means that either the data was too strong or economists were too negative) whereas today they are more generally optimistic? It would be entirely consistent with how the Fed has been run for the last couple of decades if monetary policy was not being guided by actual data, but by forecasts of data. (See my book for more on monetary policy errors!)
Evidence is pretty clear that recently economists as a whole have not only been wrong, but wrong in a biased way, which is much worse. If you are merely a bad shot, you miss the target in all kinds of directions. But if you persistently miss the target in one direction, then it may well be that your weapon sights are not properly calibrated. The first sort of unbiased miss is not as dangerous, even if too much confidence is placed on the shot, because the errors will even out over time. You might eventually hit the target, by accident. But if the target sights are biased, then you will never hit the target until you realize you’re wrong. You would be tightening when you should be easing. A broken clock is right twice per day, but only if it is stopped and not just systematically two hours off.
Now, regular readers of these columns will understand that I don’t think the Fed should be easing. I don’t think the Fed can fix what ails growth, since monetary policy only affects the price variable, and easy money has only created the conditions for the inflationary upswing we are currently experiencing (Gross also acknowledges this, but sees the inflationary upswing somewhere in the unthreatening future while in fact it is here now). The Fed should have eschewed QE2 and QE3, and have long since begun to drain excess reserves. But what I think the Fed should do and forecasting what I think they will do are two very different things.
I suspect Gross is close to right. Absent some recovery in the real economy – something other than payrolls, which as we know lag – it strikes me as unlikely the Fed will be hiking rates again. Ironically, that may help keep inflation leashed for longer since it will help keep monetary velocity constrained – but I am not confident of that, given how low interest rates already are. Since inflation is very unlikely to wane any time soon, I think we are more likely to see the yield curve steepen from these levels, rather than flatten. A yield curve inversion is not a prerequisite for recession. Inverted yield curves tend to precede recessions only because the Fed is typically slow to lower interest rates in response to obvious weakness. In this case, rates are already low and the Fed isn’t likely to raise them and force a curve inversion. Yield curve inversions are not causal! This next recession may catch some people wrong-footed because they keep waiting for the inversion that never comes.
In my next article, I am going to revisit an issue I first addressed a couple of years ago and which might be especially relevant as recession possibilities increase: the question of how we can have both deflation and inflation, and how these concepts are often confused by those people who are stuck in the nominal world.
In yesterday’s article, I neglected to mention one remark by a former Fed chair that bothered me at the time. However, I didn’t mention it because I thought the reason it bothered me was that it was vacuous – the sort of throw-away line that someone uses to stall while thinking of the real answer to the question. Since then, I’ve realized what specifically annoyed the subconscious me about the remark.
When Bernanke was asked about whether a recession is coming at some point; he glibly replied “Expansions don’t die of old age,” as if that was obvious and the questioner was being a dolt. Like so much of what Bernanke says, this statement is both true, and irrelevant.
Human beings, also, don’t die of old age. There is a cause of death – something causes a person to die; it isn’t that their library card of corporeality became overdue and they expired. The cause may be a heart attack, a slip-and-fall in the bathtub, cancer, pneumonia, complications from surgery, or the flu, but death is the result of a cause. It just happens that as a person gets older, the number of potential causes multiplies (a newborn rarely has a heart attack) and the number of causes that become fatal to an old person, where they would be merely inconvenient to a hale person, increases as well. As we age, parts of our bodies and immune systems weaken – and that’s where death sneaks in.
Think of those weaknesses as…let’s call them imbalances that have accumulated.
The statement that expansions don’t die of old age is literally true. Something causes them to die. It may be monetary error, but as Volcker pointed out last night in answer to a different question, there were recessions long before there was a Federal Reserve. Expansions also can die from a diminution of credit availability, from energy price spikes, from malinvestment, from an overextension of balance sheets that leads to bankruptcies…from a myriad of things that may not kill a young, vibrant expansion.
The parallel is real, and the point is that while this expansion was never very vibrant the current imbalances are legion. The Fed may not see them, or may believe them to be small (like Bernanke’s Fed felt about the housing bubble and Greenspan’s Fed felt about the equity bubble). But the Fed has a fantastic record on one point: they are nearly flawless at misdiagnosing a patient who is sickening.
Thursday evening’s public discussion between Fed Chairman Janet Yellen and former chairmen Volcker, Greenspan, and Bernanke – these last three in order of gravitas and effectiveness and (perhaps not unrelatedly) reverse order of academic accomplishment – was a first. Never before, apparently, have four current and former Fed chairmen appeared on the same stage. This is less amazing than it seems: prior to Alan Greenspan it was the practice of the Federal Reserve to remain out of the limelight.
Honestly, we all probably would have been better off had they stayed there.
Still, it was a fascinating event. The International House, which hosted the event, called it the “Fabulous Four Fed chairs,” but since they did not serve contemporaneously a better image is probably Mount Rushmore…if Mount Rushmore had the faces by Nixon, Hoover, Carter, and Andrew Johnson instead of Washington, Lincoln, Teddy Roosevelt, and Thomas Jefferson.
Okay, all bond guys have a soft spot for Paul Volcker, who was the last Fed Chairman to try monetarism and managed to break the back of inflation using its common-sense prescription. But he should have stayed retired. The Volcker Rule has sucked a tremendous amount of liquidity out of the market (in conjunction with other Dodd-Frank rules) and is clearly a stain on his resumé.
Everyone was hoping that this collection of experienced policymakers would give us some clear consensus about what the Fed should do now – raise rates as per the original path that was implied? Raise rates more slowly? Maintain rates? Keep on adding liquidity? Instead, there was almost nothing useful to be gleaned from the conversation. The three ex-chairmen seemed to be competing to make the funniest statement (some intentionally, and some unintentionally like Bernanke’s statement that “unwinding the balance sheet is very straightforward”) without saying anything constructive, challenging, or even useful about current and future Fed policy; Yellen seemed to want to say useful things but it isn’t clear she has anything useful to say.
One overwhelming consensus was that the economy is doing just fine, but isn’t a “bubble economy.” Volcker did allow that “there are aspects of the financial world that are overextended.” Oh, do you think so? Maybe something like the chart below, which is an updated version of Figure 9.7 from my book?
Here are two other interesting snippets:
- Bernanke, asked “how will you unwind” the extraordinary measures he instituted, wisecracked “Fortunately, I don’t have to,” which considering the scale of what he did is a clever witticism that I am sure Dr. Yellen appreciated. After expressing, as I noted earlier, that unwinding is really easy, he pointed out languidly that the Fed’s balance sheet, relative to GDP, is “about the same size of most other central banks.” Does he really think no one was paying attention since 2008? The reason all central banks have huge balance sheets is that the Fed did it first and they all followed. If you consider “most other central banks” to include others throughout history…no, it’s not even close.
- Yellen didn’t address the elephant in the room, but went so far to pat its rump and then pretend it wasn’t there. She described the criteria the Fed had had for the December increase in interest rates (substantial progress towards employment goal, and inflation heading back up), but didn’t feel like explaining that when even more progress had been made on employment, and inflation was even higher, at the next two meetings the Fed decided to pass. She noted that “headwinds” in the “legacy of the financial crisis” and “weak global growth” meant that “the neutral rate is very low,” but unless that neutral rate happens to be 0.25%-0.50% such a comment begs the question. Those headwinds haven’t gotten any worse since December! As such, she left completely unanswered the $64,000 question which is “what the heck would make you tighten again?”
In short, all of these notable central bankers (which is a little like saying “these notable hobos”) seemed to agree that everything is just fine and there is no urgency with respect to anything right now. I’ve spent the last quarter-century deciphering three of these four speakers, and I must say I can’t decide whether “everything is fine” means “the Fed can go ahead and tighten now, because everything is fine,” or “there’s no reason for the Fed to tighten now, because easing forever doesn’t seem to be a problem.”
So, markets remain suspended from the pendulum of complacency, which right now seems to be quite a bit on the “complacent” side but will, I suspect, shortly swing the other way to “disturbed and uncomfortable”. I must say that nothing I heard tonight suggests further Fed tightening is imminent. However, that point in itself makes me disturbed and uncomfortable and at some point the market will oscillate around to that view – perhaps next Thursday when I think there is a good chance that core CPI rises to 2.4% y/y.
Administrative Note: On Friday at 4pm ET, I will be on Bloomberg TV’s “What’d You Miss?” with Joe Weisenthal, Alix Steel, and Scarlet Fu.
 In keeping with my usual tilt to keep focused on inflation and real values, it should be noted that the $64,000 question would today be the $523,277 question. The quiz show ended in November 1958 with the CPI price index at 29; it is now at 237.111.
 Interestingly, this last point directly echoes some of Keynes’ points in the General Theory. I will revisit that point next week.
(**Administrative Note: Get your copy of my new book What’s Wrong with Money: The Biggest Bubble of All! Here is the Amazon link).
I am often critical of central banks these days, and especially the Federal Reserve. But that doesn’t mean I think the entire institution is worthless. While quite often the staff at the Fed puts out papers that use convoluted and inscrutable mathematics to “prove” something that only works because the assumptions used are garbage, there are also occasionally good bits of work that come out. While it is uneven, I find that the Atlanta Fed’s “macroblog” often has good content, and occasionally has a terrific insight.
The latest macroblog post may fall into the latter category. Before I talk about the post, however, let me as usual admonish readers to remember that wages follow inflation; they do not lead or cause inflation. That reminder is very important to keep in mind, along with the realization that some policymakers do think that wages lead inflation and so don’t get worried about inflation until wages rise as well.
With that said, John Robertson and Ellyn Terry at the Atlanta Fed published this great macroblog article in which they present the Atlanta Fed’s Wage Growth Tracker. Here’s the summary of what they say: most wage surveys have significant composition effects, since the group of people whose wages you are surveying now are very different from the group you surveyed last year. Thus, measures like Average Hourly Wages from the Employment report (which has been rising, but not alarmingly so) are very noisy and moreover might miss important trends because, say, high-wage people are retiring and being replaced by low-wage people (or industries).
But the Atlanta Fed’s Wage Growth Tracker estimates the wage growth of the same worker’s wage versus a year ago. That is, they avoid the composition effect.
It turns out that the Wage Growth Tracker has been rising much more steadily and at a higher rate than average hourly earnings. Here is the drop-the-mic chart:
With this data, the Phillips curve works like a charm. Higher employment is not only related, but closely related to higher wage growth. (For the record, Phillips never said that broad inflation was related to the unemployment rate. He said wage inflation was. See my post on the topic here.) The good news is that this doesn’t really say anything about future inflation, and what it means is that the worker who is actually employed right now is still keeping pace with inflation (barely) thanks to relatively strong employment dynamics.
The bad news, for Yellen and the other doves on the FOMC, is that if they were hiding behind the “tepid wage growth” argument as a reason to be suspicious that inflation will not be maintained, the Atlanta Fed just took a weed-whacker to their argument.
(**Administrative Note: Get your copy of my new book What’s Wrong with Money: The Biggest Bubble of All! Here is the Amazon link.)
I was surprised in December when the most dovish central banker ever to lead the Fed allowed the body to implement a tightening, so perhaps I shouldn’t be surprised now that she is staunchly resisting an increasingly-raucous chorus of hawks. Prior to the Fed’s last meeting, I noted that if there was ever an excuse for tightening, unemployment being around 5% with core CPI above 2% while emergency measures still remain in place from the last crisis was probably a pretty good one. When the Fed eschewed action at the meeting, I scratched my head even though I wasn’t totally shocked. Yellen is a dove, and an unrepentant one at that. Despite all efforts to rehabilitate her image in that regard, the truth remains.
But her arguments are getting increasingly weak. Her argument seems to be that if domestic growth is weak, then even if inflation is rising the Fed will maintain the extraordinary measures as long as inflation is not yet at disturbing levels, or if the inflation is believed to be transient. Okay, fair enough – I believe it’s the wrong tine of the fork to focus on, since in the long run growth is maximized when inflation is low, stable, and predictable (as Greenspan once was fond of reminding us) and because the Fed can actually control inflation through monetary policy while there is little evidence they can control real growth. But still, it’s a point that many at the Federal Reserve would agree with.
However, in her remarks on Tuesday Yellen went further and pointed to weakness in other parts of the world where the Fed clearly has no direct mandate but also where it isn’t clear the weakness isn’t a net positive for the US in terms of our growth/inflation tradeoff. Lower energy prices due to weak growth in Europe and China, for example, has a positive impact on the United States which almost certainly outweighs the decline in our exports to those countries.
Yellen’s argument sounds a lot like what you will sometimes hear around bonus time at a large company (and perhaps here I will reveal lingering frustrations of my own!). In some companies, what you hear at bonus time if your group or your particular project did really well is “you did well, but we can’t pay you as much as it deserves because the firm/the division/the group came in below plan.” At the same organization, if your group or your project did poorly while the overall firm had a banner year, the bonus time discussion will begin with “well, as you know you didn’t perform well…”
Growth will always be weak somewhere in the world. Soon enough, it will probably be weak here. But even when it weakens here it is not likely to be so weak that we continue to need extraordinary liquidity provision such as that which is currently in place.
Yes: to me, the bigger issue is the size of the Fed’s balance sheet and the global pile of excess reserves. Higher interest rates from the central bank are not only not a cure, they make the problem worse by causing money velocity to increase. But I would be somewhat less uncomfortable if there was any indication that the Fed had some sense of urgency on the inflation front.
In any event, if the Fed does not raise rates in April then it means it will be at least 6 months between 25bp rate increases. At that rate, it would be about six years until the short rate returned to something like a normal level. But that’s irrelevant – because a change in rates every six months cannot be seriously called a tightening “campaign.”
The Fed’s credibility erodes further with every passing day. The good news is that there isn’t much left to erode.
Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments. Plus…buy my book about money and inflation, just published this month! The title of the book is What’s Wrong with Money? The Biggest Bubble of All, order from Amazon here.
- Good morning and welcome to another wonderful CPI day!
- Three notes before CPI prints in 17 minutes: First, the market is expecting a “soft” 0.2% core (something like 0.16%, rounding up)
- Second: If we get exactly 0.2% core, then y/y will round higher to 2.3%. Third: if we get exactly 0.3%, y/y core will round to 2.4%.
- Highest core print since the crisis was 2.32% in 2012. We have a shot of exceeding that today with a robust print.
- Ten minutes to CPI and time for 1 more coffee and a commercial message: please buy my new book! http://amzn.to/21uYse8
- whoopsie, core CPI +0.3%. Actually 0.28%, puts y/y at 2.34%. Yayy, a new post-crisis record!
- Ouch, seems like a big jump in y/y Medical Care, waiting for the breakdown. If so, that makes core PCE jump even more (again).
- So back to back months we’ve had 0.29% and 0.28%. I hate to say I told you so but…
- I said 2.33%, Actually 2.34%. We were VERY close to printing 2.4% y/y & setting off panic at the Fed. Which is abt 4 yrs overdue.
- I should say 4 years and $2 trillion overdue.
- [retweet from @boes_] Core consumer price inflation ex-shelter really accelerating: was 1.6% year over year in February
- core cpi. What, me worry?
- while I wait for my sheets to calculate, let me stress this is not meaningless for the FOMC meeting today.
- Arguments for waiting another meeting before raising rates are very thin. https://mikeashton.wordpress.com/2016/03/14/feeble-arguments-against-a-rate-hike/
- i have got to put this database on a faster computer. OK, core services 3.1% from 3% and core goods +0.1% from -0.1%.
- first positive y/y in core goods in two years.
- Housing: 2.12% from 2.10%. Primary rents (3.68% from 3.71%) and OER (unch at 3.16%) are NOT the drivers of the core jump.
- Lodging away from home 4.19% vs 2.67%, but that’s a small piece of CPI (<1%)
- Apparel had big jump in y/y rate to 0.89% from -0.53%, but again Apparel as a whole is 3% of headline, 4% of core.
- Medical care: 3.50% from 3.00%. Yep.
- Drugs 2.34% from 2.21%. Professional svcs 2.54% from 2.08%. Hospital svcs 4.90% from 4.32%. Health insurance 5.97% from 4.76%. Ouch.
- Med care is ~10% of core, so that 50bp jump is 0.05% on core.
- And remember, Medical care gets a HIGHER WEIGHT in the Fed’s preferred measure, core PCE.
- U-G-L-Y CPI ain’t got no alibi. It’s ugly (woot! woot!) it’s ugly.
- The good news is pretty thin gruel. Median CPI should be +0.22% or so, keeping y/y around 2.42%. At least it isn’t running away yet.
- Also, NEXT month we roll off an 0.21% from the y/y figure. So the hurdle will be higher for an uptick in core CPI.
- Like I said, thin gruel. There can be no doubt whatsoever that deflation risks are zero for the foreseeable future.
- Stocks are doing tremendously well with this, only -9 points or so S&P futures. This is awful news for equities.
- …but some observers like to spin “rising inflation” as “sign of robust growth.” Nope. See “1970s” in your encyclopedia.
- The only way this is good news is if you recently wrote a book on inflation. Which, as it turns out, I did: http://amzn.to/1RNTjZu
- Distribution of price changes. You can be forgiven for seeing this as giving the Fed the finger.
As much as I like to talk, there’s just not a lot more to say. This number is awful, as it not only was well above expectations (the m/m figure was about double the rise which analysts expected) but also it wasn’t driven by shelter but rather by Apparel (a little) and – worst of all – Medical Care. Here is a chart of y/y Medical Care (Source: Bloomberg).
Here is a subcomponent of medical care, “Professional Services” (Source: Bloomberg).
And finally, again, here’s the context. This chart (Source: Bloomberg) shows median inflation (top line), core inflation converging on it (middle line), and core PCE shooting higher (bottom line). Note that the top and bottom lines are not updated for the most-recent month.
At this hour, stocks are inexplicably unchanged. This is awful news for stocks, which tend to be most-highly valued when inflation is low and stable and the Fed is quiescent. Now we have inflation that is moderate, but rising, and a Fed which is not only active, but with numbers like this may eventually become more so. If they do not, it is only because growth is weak (and weakening)…and someone please explain to me why that is a positive environment for stocks? One can make an argument that bonds can do okay if growth flags (even though growth does not cause or lead inflation), because real rates are too high for the level of nominal rates and that could conceivably reach equilibrium by TIPS rallying rather than nominal bonds selling off. But it’s a hard argument to be bullish on the big two asset classes. (However, I expect Wall Street to make that argument loudly.)
(**Administrative Note: Get your copy of my new book What’s Wrong with Money: The Biggest Bubble of All! Here is the Amazon link.)
We look forward to a week filled with data including CPI, the Empire Manufacturing report, Housing Starts, Industrial Production, and Existing Home Sales – not to mention the important primary election contests in Ohio and Florida tomorrow. But at the top of the list of important events is the FOMC meeting on Wednesday.
The consensus of Wall Street economists right now is that the FOMC will leave interest rates alone. The consensus is almost universal that the Fed will choose to skip this week’s meeting. So, in keeping with my general role as a gadfly, I want to give some reasons why the Fed might very well choose to raise rates.
One place to start is by examining the arguments for not raising rates. Before I do that, let me assure readers that I have not changed my opinion that this is the most dovish Federal Reserve in history. But, since they have broken the skin on the milk we can no longer consider the possibility that there is no way this Fed would ever hike rates. Prior to the December meeting, it was plausible to think that the hurdle for hiking was very high and that it was possible that 2016 might end with rates still at zero. The question is, though, no longer whether the Fed is willing to hike rates, but whether they currently want to hike rates…and when.
Here are what I see as the main arguments for skipping a rate hike at this meeting:
(1) While the US economy is doing okay, the global economy is weak especially in Europe.
I will take here a somewhat different tack than some other observers might. The standard answer here is “the Fed is not responsible for the global economy, but for the US economy.” This is true, but since I don’t think changing interest rates 25bps in an environment of abundant liquidity has any meaningful effect on domestic or global growth my perspective is different. The ECB just lowered rates, in large part to put downward pressure on the Euro versus other currencies and hence to help Euro growth and inflation. By raising rates, the Federal Reserve would actually reinforce that move, since doing so would tend to strengthen the US dollar and other pegged or semi-pegged currencies against the Euro and other units. So in my view, if the Fed wants to help other economies and is not worried about the domestic economy so much…the solution is actually to raise rates, not to keep them stable or lower.
(2) The Fed needs to remain wary of the risk of deflation.
With inflation at the highest levels since the crisis, with median inflation above the stated FOMC target (and core CPI inflation at the target, with core PCE below but rising rapidly), this seems like a crazy thought process that doesn’t really require a lot of discussion to dismiss. If inflation at 2.0%-2.5% and rising is representative of an economy at risk of deflation, then up is down, down is up, and we should just forget the pretense that we care about the data. If 2.5% and rising is at risk of deflation, then where are we safe? 3.5% and rising? 4.5% and rising? If the Fed doesn’t want to stop inflation now that it has reached the target, what does it mean to have a target?
(3) Domestic growth is not yet strong enough to sustain higher rates.
If near-zero rates for the better part of a decade has not healed the economy, then maybe the low rates are the problem and not the solution. In any event, how much stronger is the economy likely to get than a 4.9% unemployment rate? Yes, the forward indicators aren’t looking great but if the Fed won’t hike when Unemployment is at 4.9% then they probably aren’t going to hike when Unemployment is above 5% either. This is actually an argument for getting another tightening in before the Fed needs to consider reversing policy later in the year.
(4) Asset markets can’t take it. Hiking rates would push stocks and bonds lower.
Even though the Fed tries to persuade us that they don’t worry much about markets, we know that’s not true. But it would seem to be odd to worry about them now when the S&P is down 1.2% on the year, and the cyclically-adjusted P/E is in the top 5% of historically recorded values. Bond yields are near the lowest levels of the last hundred years, real yields still well below 1% out to 10 years (and negative inside of 5 years, and remember I think these are much cheaper than nominal bonds). Real home prices are the most above trend, excepting only for the late lamented bubble, on record (see chart, source Shiller, Irrational Exuberance, 3rd edition as updated by author).
Some would say that it would be a good thing for asset prices to be lower, so that the people of this world who are going to be net investors for the next 20 years get better future returns. But in any event, it is hard to argue that asset markets are ailing in any particularly terrible way.
(5) The market isn’t expecting the Fed to raise rates.
Well, why the hell not? The Fed has said “as conditions warrant.” Well, they warrant. True, the FOMC doesn’t want to surprise the market and they haven’t done any work at suggesting they’re about to hike rates…other than putting the rate-hike campaign in motion in the first place…but in this case it is hard to understand why we should not be expecting the Fed to raise rates. If not now, when?
Look, the Fed has set the hurdle on growth and inflation, and it is hard to argue the economy hasn’t cleared those hurdles. I think, therefore, that the market is under-appreciating the probability of a rate hike on Wednesday. Yes, if they raise rates the very next thing they will do is move those hurdles farther away. But if they don’t raise rates at this meeting, the only argument can be “it’s March and people aren’t expecting one until April.” That seems to me to be a fantastically feeble argument, although one must grudgingly admit that feeble arguments are the stock in trade of central banks these days.