It’s rarely a good idea to accept the prevailing, “consensus” narrative as gospel because generally speaking, once something becomes the “consensus” view, it’s outdated and prone to blowing up in relatively short order.
That’s an anecdotal assessment, but you get the idea. When everybody ends up on the same page, it’s usually about time for that page to get turned and invariably, nobody is prepared for it.
So it’s probably a bit tenuous to just go ahead and accept as a foregone conclusion the notion that because the U.S. economy continues to perform strongly and because the trade tensions with China are worsening literally by the day (tipping an inevitable rise in consumer prices stateside as the Trump administration is forced to hit finished goods in the next two rounds of duties on Chinese imports), that the Fed is destined to keep hiking.
That said, it’s hard to imagine how things could possibly play out differently at least in the near- to- medium term.
There’s supposed to a kind of built-in circuit-breaker here. Fed hawkishness drives the policy divergence between the U.S. and the rest of the world wider, leading to persistent dollar strength and past a certain point, the negative impact of the dollar’s rise on emerging markets tips EM into crisis mode and the Fed falls back on “international developments” as an excuse for taking a pause.
But there are two things that make that a less-viable option in the current environment. For one thing, the above-mentioned combination of an overheating U.S. economy and the threat of tariff-related price pressures make it difficult for the Fed to lean dovish. Additionally, Trump’s criticism of the Fed paradoxically raises the bar for a pause on hikes, because any such dovish lean could open Jerome Powell up to accusations that Fed policy is being unduly influenced by Donald Trump.
The above-consensus average hourly earnings print that accompanied the August jobs report seems to suggest that the “missing” wage growth is no longer “missing”, and if true, the Fed would lose the last excuse they had when it comes to staying some semblance of gun shy in the face of a U.S. economy that’s firing on all cylinders.
The market is starting to get the idea. As Bloomberg notes, “the implied yield on January fed funds futures on Tuesday climbed to an unprecedented 2.36 percent, indicating around 44 basis points of additional tightening by the end of December.” Folks are starting to believe in the dot plot, it would appear.
Just to underscore how sure everyone is about the narrative, check out the title of the latest note from Goldman’s Jan Hatzius:
Nothing ambiguous about that.
“The big picture is that US economic growth remains very strong”, Hatzius writes, adding that “the sharp rebound in both ISM surveys kept our CAI at 3.7% in August, while our Q3 GDP tracking estimate has edged back up to 3.2%.”
He goes on to note that labor market tightness is manifesting itself in a number of places and when it comes to wage growth, Goldman reminds you that while AHE prints are “noisy” by nature, “the highest-quality indicators of US wage growth are now all near 3%.”
As far as the trade war is concerned, Hatzius writes that the short-term effects haven’t really been negative, while the longer-term impact in terms of “business uncertainty, potentially tighter financial conditions, a hit to supply chains, and non-tariff retaliation” is difficult to measure ahead of time.
That said, Goldman does caution that going forward, everyone will need to take seriously the prospect that tariffs will drive up prices. To wit:
The inflation effect of higher tariffs is starting to become a bit more important. This is partly because the starting point for core inflation is higher, partly because the incremental amount of goods affected is now much greater than in prior rounds, and partly because the focus is inevitably shifting toward consumer goods. Our best estimate is that the tariffs imposed to date plus the $200bn China round will boost the core PCE index by about 0.1pp; further tariff rounds—including the remaining $267bn in imports from China and the potential auto tariffs—could triple that number in a worst-case scenario.
Hmmm. The bottom line, for Goldman anyway, is that there will be six more hikes through the end of 2019.
Trade accordingly. Or rest assured that once everyone becomes “sure” of the narrative, it’s bound to turn on a dime. Whichever.