Tough to keep up with this week’s news, and more is on the way. We still have the jobs report ahead of us! In the interest of time, I am going to move through this quickly:
1.) The Fed held rates steady yesterday. The basic policy outcome was not a surprise. Federal Reserve Chairman Jerome Powell’s sanguine view of low inflation, including the claim that “transitory” factors were driving low inflation, was a surprise. Powell gave little reason to think the Fed was particularly concerned about the seven years of sub-par inflation outcomes since the Fed adopted its mandate. It doesn’t seem like the Fed is updating its view of inflation in light of the past history of data. This wouldn’t be so confusing if the Fed hadn’t been leading market participants to think that low inflation was a significant concern and could prompt a rate cut. The Fed’s basic story is that any inflation at or above 2% is always defined as persistent while any inflation below 2% is always defined as transitory. I am having trouble squaring this conclusion with the claims that they have a symmetric inflation target; it looks like that claim is all talk.
2.) The Fed lowered the interest rate on excess reserves. There appears to be some angst over this move as if it indicates the Fed can’t control rates. I don’t think this is the case; the angst appears to stem from the fact that IOER rates have tended to be ceiling on the federal funds rates in recent years. I always thought this was more likely than not a temporary situation. I have had this from New York Fed’s Simon Potter in the back of my head for years:
As a result, as the level of reserves declines during normalization, marginal balance sheet costs should fall, competitive frictions should lessen, and the demand for additional reserves from individual banks should increase. These factors should strengthen the magnetic attraction of IOER and pull the fed funds rate and other market rates up toward—and at some point equal to or above—the IOER rate.
I don’t think we should be surprised if the IOER rate continues to fall toward the bottom of the Fed’s target range for the federal funds rate.
3.) Productivity growth is surging and labor cost growth holds at low levels. Continued acceleration in productivity growth would clearly be good news as it suggests a higher speed limit for the economy; it would also help make up for some lost ground from the expected slowing of the labor force. In addition, low unit labor cost growth justifies the Fed’s continued “patient” policy stance. High wage growth doesn’t automatically translate into inflation, but it’s tough to have inflation concerns when unit labor costs are low. Two points to note: As low productivity is often cited as a reason for low neutral interest rates, persistently higher productivity growth should translate into higher neutral interest rates, which should over time put upward pressure on the yield curve. Second, Ernie Tedeschi cautions us that the fall in unit labor costs might be related to the impact of the tax cuts. That said, even if unit labor cost was running at the rate seen prior to the tax cut, it wouldn’t be worrisome.
4.) Manufacturing indicators came in on the soft side. The ISM measure was weak in April, but not recessionary or even as weak as the 2015-16 era. Consistent with a softer pace of manufacturing activity and further justifying the Fed’s pause, but not particularly worrisome. Also note that even if manufacturing were sliding more deeply, a lesson from 2015-16 is that manufacturing is less important to the overall economic cycle than in the past.
5.) Initial unemployment claims remain high for a second week. Best story here is that the later Easter holiday is playing havoc with the seasonal adjustment process. In addition, maybe a little more dispersion of rate increases across states still evident, but again, like ISM, nothing particularly worrisome.
6.) High expectations for the job market. Wall Street, in part responding to a solid ADP employment report that showed a 275k in private sector employees, expects the BLS to say the economy added 217k workers in April. Strong job growth will keep the Fed wary that they moved too far to the dovish side in March and leave them less concerned about low inflation numbers.
7.) Moore is less. This morning, Stephen Moore told Bloomberg News:
“My biggest ally is the president,” he said. “He’s full speed ahead.”
About ninety minutes later, President Trump announced that Moore pulled out of consideration for the job. So this ugly chapter in Federal Reserve history is over. It’s back to the rubber chicken circuit for Moore; Republicans trust him enough to feed the base, but not enough to go to bat for him for a top job at the Fed.
That’s it for now.