Fed In ‘Unenviable’ Position. Risks ‘Potentially Incoherent’ Messaging
This time last month, US financial conditions, as measured by various Wall Street gauges, were setting up for one of the more dramatic easing impulses in recent memory.
The tide was already turning courtesy of Treasury's polite nod to supply concerns in the refunding announcement and a (relatively) soft jobs report, but the real fireworks began on November 14, when a favorable October CPI update triggered exaggerated dovish price action reminiscent of the reaction to the October 2022 CPI report
Powell and company are not going to do anything to jeopardize a soft landing. They’ll keep the funds rate at these levels longer than the markets think they will.
Super-core (services ex-shelter) is running around +6% annualized and not yet in a clear declining trend. Employment and wage data are not clearly cooling down. The rent component of shelter inflation is declining and seems likely to continue declining in 2024 (based on supply), but the much larger OER component is declining but seems at risk of reaccelerating later in 2024 (based on lagged home price data). Energy deflation may be running out of gifts to give, with both oil and crack spreads not far off their 3 year lows. Goods deflation does seem sustainable, with China helping out. Overall, I think hawks on the FOMC still have to worry about finishing the job, while it is hard for me to see what economic pain doves can really claim compels easing now.
I forgot to add – the FOMC seems to be undecided if it will be model-driven or data-driven. It wasn’t so long ago that the FOMC was acknowledging that models weren’t working and vowing to be guided by data. Now people are dredging out the “Taylor Rule” to argue that rates must be cut and now? If I recall, last year the Taylor Rule was prescribing FF in the 7-8% range.
There is also not one “Taylor Rule”, but many versions which give a range of prescriptions. Here is an interesting way to generate Taylor Rule charts using various different versions of said rule.
https://www.atlantafed.org/cqer/research/taylor-rule.aspx?panel=1&s=blogmb
Defintely seems to be a number of FOMC members who would like to move toward a more rules-based model, though one less rigid than the model Taylor has long advocated (which is why, imo, his model has never been widely embraced).
IIRC, Prof Taylor himself warned that his model might not be 100% applicable when a large extraneous event occurred. Like an earthquake or, ah, even a pandemic?
Jeez JL, I do hope that they opt to be data-driven. Models keep proving to be only mildly useful in relatively calm times but useless when “low probability” events shake the built in assumptions. Like three one-in-a-hundred-year storms hitting an area in five years or there’s a pandemic or something.
I cannot understand why anyone would put much credence in static-equilibrium-based economic models in our new world of larger-than-normal geopolitical and climate-change-driven risks.
(Many hyphened terms there. They must make our Dear Leader shudder…..)
Model-led is hubris, data-driven is humility, the Fed may be feeling tentatively rather good about itself but I also hope humility is not cast aside. The last few years have broken many models, the Fed shouldn’t think its models are self-healing.
On the nose, sir, as with your comments above.
I hope someone asks Powell if FCI is truly a two way street. The Fed is on record saying a demonstrably tighter FCI could stand in for a policy rate increase (last meeting). If that’s the case, and the underlying macro is largely unchanged, then why wouldn’t a comparably looser FCI spur a policy rate increase? Are some components of financial conditions (equities) less important than others to the Fed’s assessment re their policy rate?