Focus to Shift From Fed Watching to Data Combing

August 26, 2016

In the week just ending, financial market participants were consumed with today’s scheduled speech by Janet Yellen at the K.C. Fed-sponsored Jackson Hole central banking symposium. The Fed Chair made some news by reporting progress toward the Fed goal of 2% inflation as well as its jobs growth mandate had occurred, and that the case for a second hike of the federal funds rate target is strengthening. She didn’t signal how soon the increase might occur and put the greatest emphasis in her comments on near-term monetary policy to the expectations that normalization will be a gradual process. Indeed, even if officials move in September, the interval between the first and second increases will have been ten months from an unprecedented low level. Calling that a snail’s pace would be an understatement. Yellen’s comment was comfort food for investors, and markets rallied, but that wasn’t the whole story of today. Remarks about an hour later by Vice Chair Stanley Fisher hinted that two hikes by yearend are possible, sending the dollar up and stocks and bond prices lower. Despite repeated admonitions by Fed officials and private analysts that the broad path of rate normalization, rather than the exact timing of changes, will be most important to the ultimate response of the U.S. economy and financial markets, today’s action underscored just how influential sudden shifts in perceived timing can be.

While the catalysts for such shifts this week came from the comments of officials, next week will be all about the data. A vast quantity of economic indicators are being reported by the United States and other advanced economies. One of the more forward-looking indicators will be the ISM manufacturing purchasing managers index on Thursday. Markit Economics also compiles U.S. PMI data and has released some weaker-than-expected preliminary indications already for the month of August. Its manufacturing PMI fell from a 9-month high of 52.9 in July to 52.1, and the companion services PMI dropped 0.5 points to a 6-month low of 50.9. The composite PMI (both services and manufacturing) was at a 2-month low of 51.5.

These tentative findings do not imply a big improvement in the coming quarter. Over the previous three quarters, U.S. real GDP expanded just 0.9% last fall, 0.8% in the winter, and 1.1% at an annualized rate in the spring. Moreover, growth has not been well-balanced but rather heavily dependent on the consumer. While real consumer spending in 2Q16 grew 4.4%, annualized declines were recorded by residential investment (7.7%), non-residential business investment (2.5% and the third straight quarterly drop), and government spending (1.5%). Net foreign demand augmented GDP growth by a mere 0.1 percentage point, while inventories exerted a sharp 1.26 percentage point drag. It’s highly probable that on-year GDP, which was only 1.2% in 2Q16, will be even lower in 3Q.

That puts a very heavy emphasis on all elements of next Friday’s Labor Department jobs report to justify tightening at the September FOMC meeting. The problem with moving that soon rather than at the penultimate or final scheduled meetings of 2016 that it would keep alive the possibility of two, rather than just one, rate hikes in 2016.

Then there is the election. Every four years, Fed officials say that they will not be influenced by the presidential election, but it would go against human nature this time for the election not to affect their predisposition. If Trump and fellow Republicans win in November, Fed policymakers can kiss good-bye to their independence. No monetary official can feel neutral about that prospect, not just because of losing the chance to make a difference but also because the studies show monetary policy by independent central banks achieving much better results of promoting sustainable growth with price stability than in cases where decisions are made or strongly influenced by elected officials. Because of the looming election, policy is likely to be tightened at the September meeting only if a compelling economic case exists then to do so.

It’s also clear that Fed officials are closely monitoring the dollar and its reaction to what they do. A strengthening dollar could impede both their mandates but eroding the price competitiveness of U.S. exports and import-competing goods and by directly depressing import prices. Whatever action is taken at the September meeting, the on-going inclination to normalize rates a third time will hinge on the dollar not strengthening significantly further.

Copyright 2016, Larry Greenberg. All rights reserved.  No secondary distribution without express permission.


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