Fed Lacks Consensus on Implementation, Data Generally Solid

Note: I will be out of town this week. Postings will be limited to nonexistent.

Last week I said that the Fed’s new strategy guidance, particularly the adoption of the average inflation target, was clearly written by a committee as it can mean whatever a particular FOMC participant wants it to mean. Early comments by Fed officials reinforce this observation. Via Jonnelle Marte and Howard Schneider at Reuters

A day after rolling out a new strategy for U.S. monetary policy, Federal Reserve officials on Friday diverged over what it might mean in practice, saying there is no exact formula for the average inflation rate they plan to target.

The new policy might mean 2.25% is acceptable. Or 2.5%. Or it depends on the speed inflation is changing. One thing it doesn’t depend on is any quantification of “average.” I guess R doesn’t do averages?  Cleveland Federal Reserve President Loretta Mester sums up the situation:

Recognizing when inflation has risen too much will depend on what else is happening with the economy, Cleveland Fed President Loretta Mester said. “This isn’t really tied to a formula,” Mester said in an interview with CNBC, nodding to Fed Chair Jerome Powell’s speech on Thursday in which he laid out the new strategy. “It’s really going to depend on what’s going on with the economy and how stable your inflation expectations are.”

The new strategy is really about increasing the Fed’s policy flexibility. It’s not “average inflation targeting.” The Fed removed the “average” from “average inflation targeting” because the average would become a rule and the Fed wants less rules, not more. Marte and Shneider provide a nice framing:

The comments by the Fed policymakers reflected, in part, the longer-term thinking behind the strategy document, crafted not to bind decisions at individual Fed policy meetings but to frame how the central bank is setting priorities.

The previous guidance constrained the Fed, or so they believed, to setting policy to return to the 2% target without overshooting that target. The Fed wanted flexibility to overshoot by some degree. Calling the new policy “average inflation targeting” allows the Fed to overshoot by some undefined measure. That’s all “average inflation targeting” does for the Fed. Beyond that, the strategy updates effectively alter the Fed’s reaction function to be more responsive to maximizing employment while less responsive to Phillips Curve-based inflation forecasts.

From a practical perspective, the Fed simply updated its guidance last week to match how they were already setting policy or signaling they were going to set policy: They intended to maintain very accommodative conditions until inflationary pressure were clearly evident in the data not just the forecast. Note that the variety of opinions about the exact policy implications indicates that the Fed is not yet prepared to offer additional guidance or policies intended to accelerate the expansion. That enhanced forward guidance doesn’t feel like it is coming in September.

The Fed might not offer updated guidance if the data flow continues to improve. To be sure, the Fed doesn’t appear to believe the recovery is sustainable or that unemployment will recede in any acceptable timeframe, but they don’t seem to have a consensus about any additional policy response. If the economy does in fact sustain a relatively robust pace of improvement, they might not have to issue updated guidance. And “robust” doesn’t have to mean the post-lockdown jump in the data flow; it just needs to be something reasonably better than expectations.

Initial and continuing unemployment claims continued their slow descent:

Still a glass half-empty or half-full situation. Too high, but moving in the right direction. Something that is becoming more like a full-glass situation is the manufacturing sector. New orders for capital goods are making a V-shaped recovery:

The initial decline was less steep and recovery more rapid than the 2015-16 period. This dynamic I suspect can be attributable to the very under-appreciated fact that as of February of this year, there was nothing wrong in the U.S. economy from a macroeconomic perspective. There was no bubble or misallocation of activity of any consequence that needed to be addressed. This was true even in the now beleaguered oil and gas sector that worked off its excess in the 2015-16 downturn:

Also note the V-shaped recovery developing in consumer durable goods order:

The strong housing market suggests this trend will continuing. New homes need new appliances and new existing purchases also need new appliances. Housing is being supported by very strong underlying demographics. Ignore at your own risk.

Consumer spending growth slowed:
The are reasonable concerns about the sustainability of consumer spending considering that the $600 enhanced unemployment benefits have ended. I would suggest that you balanced these concerns against the possibility that this loss is offset by job gains and that large portions of the stimulus were still funneling into savings as of July:

Household finances in aggregate continue to improve:


I suppose there could be a permanent increase in savings so this is not technically “excess.” I suppose too that pigs might fly. Seriously, American consumers are not known for their frugality. I think a wave of spending will hit the economy next year.

On a final note, Michigan consumer sentiment still hovers at pandemic lows. Inflation expectations, however, remain firm:

Something to keep an eye on if supply chains are still constricted and labor supply challenged by lack of access to child care if that wave of spending hits next year.

Bottom Line: It has become clearer that the Fed’s updated strategy, while important, really just formalizes the direction the Fed was already taking. What it does not do is create new constraints for the Fed; I think we should all come to terms with the reality that this is not really “average inflation targeting” even if we will have to keep calling it by that name. Watch the data flow and just at least be open to the possibility that there are upside risks to the outlook.

Powell Green Lights Easier Policy But Details Lacking

Federal Reserve Chair Jerome Powell delivered his much-awaited speech in which he unveiled the outcome of the Fed’s strategy and communications review. As expected, the Fed adopted a policy of average inflation targeting. There, however, was a twist. Powell describes the policy as “flexible” inflation targeting, meaning that it lacks specificity beyond a general intention to compensate for periods of undershooting the inflation target. That lack of specificity makes it a Fed watcher’s dream as it opens up range of possible policy objectives that may shift over time.

Much of the ground Powell covered would sound familiar to someone following the Fed throughout this process. The last decade has challenged the Fed’s operating framework with a falling natural rate of inflation, policy rates near the zero bound, a weakened relationship between unemployment and inflation, questionable estimates of the natural rate of unemployment, and a heightened awareness of the cost of unemployment, particularly as the costs relate to disadvantaged persons. Powell does very good job of running through the history and the motivation for the review; it will make a nice addition to my syllabus this fall.

As a result of this process, the Fed made four innovations to the strategy statement:

  1. The Fed identified the zero bound problem as constraint on policy: A lower neutral real rate translates into policy rates sufficiently close to the zero bound that the Fed will more often face the zero bound constraint when attempting to stimulate the economy. The creates a downward bias in the risks to the economy. As a consequence, the Fed is “prepared to use its full range of tools to achieve its maximum employment and price stability goals.” In other words, the Fed will continue to heavily rely on tools such as forward guidance and asset purchases. The persistence of the downside risks means that they will bring these tools to bear more quickly.
  2. The importance of employment is elevated over inflation: The Fed now describes the goal of maximum employment as “a broad-based and inclusive goal.” The Fed explicitly recognizes that a focus on headline inflation fails to account for higher unemployment among disadvantaged populations. To benefit everyone, the headline unemployment rate needs to be pulled lower than previously though compatible with full employment (in practice, the Fed uses a broad array of labor indicators in forming this assessment). The Fed also added that policy decisions will be “informed by assessments of the shortfalls of employment from its maximum level.” This replaces “deviations from maximum employment” language. “Deviations” is two-sided, “shortfalls” is one-sided. In practical terms, low unemployment itself no longer justifies tighter policy when in the absence of clear inflationary pressures.
  3. Average inflation targeting: Under the previous framework, the Fed did not attempt to compensate for undershooting the inflation target. As a consequence, the Fed appeared to be treating the 2% inflation target as a ceiling in that they tightened policy to preemptively prevent inflation from rising above 2%. The end result was inflation persistently below 2%, an outcome that may have contributed to softening inflation expectations. Now the policy allows for overshooting:

    In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.

  4. An increased focus on a stable financial system: Powell and others have frequently cited the role of financial sector imbalances in recent cycles and this fact likely heightened some concern among FOMC participants that a persistently low interest rate policy would lead to fresh imbalances that would threaten the economy. To recognize this, the Fed added this language:

    Moreover, sustainably achieving maximum employment and price stability depends on a stable financial system. Therefore, the Committee’s policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee’s goals.

This opens up the possibility of rate hikes to quell financial excess, although this remains a focus for only a minority of FOMC participants.

All well and good. Now here is the bad news: You can drive a truck through the holes in the average inflation targeting policy. It averages over an unspecified time, it only will “likely” aim to achieve “moderate” inflation again for an unspecified amount of time. As Powell further explained:

In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting.

I do enjoy that we can’t define the “average.” It sounds like the policy was written by a committee, which it of course was, and as such it likely has a different interpretation to each committee member. It is a Fed watcher’s dream come true.

At this point, the practical implication of the policy change is that they intend to maintain an accommodative policy stance until inflation at a minimum reaches 2%. Beyond that though, there is as of yet no meat on the bones of this policy. We do not know how much inflation the Fed is willing to tolerate and for how long. We do not know under what conditions they are willing to ease policy further. We do not know how long they will tolerate the long end of the yield curve drifting higher. In short, we are still waiting for operational guidance to support the new policy.

As of the July FOMC meeting, participants appeared to not have reached any sort of agreement on next steps:

With regard to the outlook for monetary policy beyond this meeting, a number of participants noted that providing greater clarity regarding the likely path of the target range for the federal funds rate would be appropriate at some point. Concerning the possible form that revised policy communications might take, these participants commented on outcome-based forward guidance—under which the Committee would undertake to maintain the current target range for the federal funds rate at least until one or more specified economic outcomes was achieved—and also touched on calendar-based forward guidance—under which the current target range would be maintained at least until a particular calendar date. In the context of outcome-based forward guidance, various participants mentioned using thresholds calibrated to inflation outcomes, unemployment rate outcomes, or combinations of the two, as well as combinations with calendar-based guidance. In addition, many participants commented that it might become appropriate to frame communications regarding the Committee’s ongoing asset purchases more in terms of their role in fostering accommodative financial conditions and supporting economic recovery.

Nor did it seem like they would focus on the issue until the strategy review was complete:

More broadly, in discussing the policy outlook, a number of participants observed that completing a revised Statement on Longer-Run Goals and Monetary Policy Strategy would be very helpful in providing an overarching framework that would help guide the Committee’s future policy actions and communications.

I don’t know that they have time to move on to operationalizing the new policy prior to the next meeting, which means the market participants may remain in the dark about the exact implementation of average inflation targeting.

Bottom Line: The Fed formalized the outcome of its policy review and left little doubt that they intended to pursue a more dovish policy path than in the last expansion. They have, however, provided few operational details. The average inflation targeting described so far looks less like a commitment to achieving an average of 2% inflation and instead just provides room to allow inflation temporarily to rise a notch above 2%. Interestingly, the lack of specificity leaves them less vulnerable to claims they aren’t meeting their target. Who knows what it is? More information is needed; look for Fed speakers for clarity. Hopefully.

Housing, Powell

New single family home purchases came in ahead of expectations:

Basically not just a V-shaped recovery, but blowing through the pre-pandemic trend. The longer view:

People get upset when you say this sort of thing, but housing is a solid leading indicator. You just don’t see a recession when housing is on the upswing; you have to be wary about upside surprises in the overall data flow.

Separately, Federal Reserve Chair Jerome Powell speaks this Thursday morning. It is widely expected that he will reveal the outcomes of the Fed’s policy review and indicate that the Fed will be adopting some form of average inflation targeting. The Fed’s objective under such a scheme will be to allow inflation to rise above the 2% target to at least partially compensate for below target outcomes. The given rational will be that this will allow the Fed to more quickly meet its employment mandate and will help firm up inflation expectations in the low inflation, low interest rate world. Operationally, the Fed will lean more heavily on actual inflation than inflation forecasts derived from Phillips curve-based models and will pursue a lower for longer interest rate policy.

There is a temptation, which I share, to think Powell’s speech will be of little consequence because the Fed has already telegraphed these outcomes. The historian Peter Condi-Brown offers this alternative take:

Those of us following the story may want to see Powell’s speech as little more than a formalization of what we already knew. Arguably, this is because we are too close to the topic. Had the Fed adopted this approach in the last expansion, it would not have raised rates so early nor as high. It would have been a significant difference relative to the actual outcomes.

Bottom Line: The strong housing market is a solid indication that we should not too heavily discount the possibility of a more robust expansion than currently anticipated. At the same time, Powell is giving a speech that can only be effective if it leaves no doubt that the Fed is absolutely, certainly locked into the current policy path or an even easier policy path. That combination has some fairly positive implications for the outlook.

Monday Morning Notes, 8/24/20

These are the topics I am thinking about as the week begins:

Bloomberg Opinion

My article from Bloomberg last Friday:

There is $1 trillion stashed away in the U.S., and it just might save the economy. It’s enough to either boost consumer spending by at least $78 billion dollars a month over the next year or supercharge growth if confidence soon turns higher….

Continued here.

HS Markit PMI

Continuing on the theme that maybe the recovery will be more rapid than expected by the conventional wisdom, the IHS Markit PMI flash report for August came in stronger than expected:

U.S. private sector firms signalled a strong upturn in business activity in August, with both manufacturers and service providers registering expansions. Notably, it marked the first rise in service sector activity since the start of the year, while goods manufacturers recorded the fastest increase in production since January 2019.

Importantly for an economy still struggling with layoffs:

Increased sales and an uptick in backlogs of work reportedly sparked a strong rise in workforce numbers midway through the third quarter. The rate of employment growth was the steepest since February 2019.

One point I continually make in speeches: From a macroeconomic perspective, there was nothing wrong with the U.S. economy in February, no obvious imbalances. Lacking any excesses to work off, there is room for a more rapid recovery than experienced in the last cycle. We focus a lot on the downside risks; don’t forget about the other side of the distribution.

Hot Housing

Existing home sales exceeded the pre-pandemic level:

A solid V-shaped recovery continued for the housing sector. Tight inventories are pushing prices higher:

The hot housing market has three big implications. First, the economy tends to follow housing, which means the recovery will likely continue. Second, household wealth is expanding, which could support spending in a big way when confidence moves higher. Third, by itself  a home purchase supports upwards of $3,700 of additional spending.

Job Openings Still Very High

We know that job openings have fallen since the pandemic began. What is less appreciated is that they are still very high relative to 2009:

This struck me as particularly interesting:

The level of job openings in accommodation and food services is three times the 2009 level. How can that possibly be the case? The labor market is now operating well off it’s traditional Beveridge curve relationship:

A high degree of uncertainty can push the Beveridge curve out by making firms less willing to commit to filling open positions. That uncertainty is heightened now because so many of these lost jobs are still considered temporary rather than permanent. If that uncertainty were to dissipate more quickly than anticipated while job openings remained high, unemployment might snap back to pre-pandemic levels more quickly than anticipated. Think again about the IHS Markit and housing reports. I know, this isn’t the conventional wisdom, but that’s what makes it interesting.

Is The Recession Over?

If the recovery continues to improve, even at a slower pace, the recession may have ended during the summer,  at  least  according to traditional timing  indicators:

Don’t hate the messenger.

Trading Places?

As Covid-19 cases start to trend down in the U.S., they are trending back up in Europe:

Spain is now at the U.S. rate. Will the rest of Europe also close the gap? Two big narratives could fall apart. The first is that Europe is doing a better job of containing the pandemic than the U.S. The Covid-19 virus is insidious for everyone; you can’t let your guard down it appears. That said, I still doubt that there will be another round of generalized lockdowns like we saw earlier this year, especially after the U.S. appears to be gaining some control without shutting it all down again. I think we are more likely to continue to see rolling, localized fluctuations in restrictions than national lockdowns. It’s just not clear we can get away with that twice. The West is not China:

The second follows from the first, that because Europe has a better handle on the pandemic the European economy will recover more quickly. Obviously, if the U.S. and Europe trade places, it might in turn derail some interest in the weak dollar story. I noticed this too via Bloomberg:

For money managers nervous about U.S. equities at all-time highs during an economic crisis and election year, Europe could be the antidote.

Investors from BlackRock Inc. to Manulife Investment Management say the region’s coordinated and fast response to the pandemic is also a good reason to be confident, despite the fact that European stocks have stalled since early June.

That trade might end in tears if Europe takes over the U.S. in Covid-19 cases.

Jackson Hole

The annual Jackson Hole event goes virtual this year. Federal Reserve Chair Jerome Powell will be speaking Thursday morning. He is expected to give a preview of the outcome of the Fed’s policy review strategy. There are fairly low expectations going into this speech. It seems possible if not likely that all the ink spilled on this process will yield only some flavor of an average inflation targeting strategy. While important, this seems to be more of a tweak to the existing framework than a grand redesign (I am not sure we could have expected anything else). The practical implication is that the Fed will hold rates lower for longer, but there will not be a new mechanism to accelerate the pace of recovery.

Bottom Line: There are a lot of moving pieces right now that I read as telling me the certainty we had a couple of months ago about a slow recovery is very much less certain now.

Quick Notes Thursday 8/20/20

Initial claims disappointed by edging up above one million:

The decline unfortunately remains slow. Same too for continuing claims:

There are no miracles happening here; the most pandemic-impacted sectors will recover only slowly until we gain a better hold of the virus. Obviously, the end of the additional $600/week of unemployment benefits is worrisome in this environment. It is an unfortunate fact though that it is important to separate the micro stories from your macro narrative:

Keep an eye on these high frequency spending measures. They haven’t rolled over yet.

Coner Sen notes that household wealth may have reached a record high in Q2:

A paradox of this economic crisis is that while U.S. employment remains 13 million below its pre-pandemic peak, the net worth of American households may be at a record high, thanks to the soaring prices of stocks and homes.

I don’t think the conventional wisdom has completely processed the potential implications of the massive improvement in household balance sheets this year. Watch for my piece on this topic in Bloomberg tomorrow morning. For a bit of a preview, checkable deposits grew by roughly $1.3 trillion during the crisis:

That is a lot of unplanned saving, a lot of hot money.  It could flow out slowly or it can rush out and slam into the economy once confidence turns higher. It’s the forgotten trillion dollars that won’t stay forgotten forever.

Finally, the Federal Reserve confirmed that Chair Jerome Powell will speak at this year’s Jackson Hole conference. His topic will be the “Monetary Policy Framework Review.” I suspect the text will focus on the reasoning behind the review and the process itself and give a preview of the outcomes without doing the full reveal that is anticipated to come in September. Market participants generally anticipate the framework will conclude with a shift toward an average inflation targeting framework that requires some modest overshooting of the 2% target; I don’t know that Powell will confirm, but I doubt he will deny.

Happy end of week!

Fed Puts Yield Curve Control On The Shelf

The minutes of the July 2o2o FOMC meeting were released today. They were somewhat disappointing  as they walked back expectations that further policy action would soon arrive. 

The Fed is moving closer to concluding its policy review:

Participants agreed that, in light of fundamental changes in the economy over the past decade—including generally lower levels of interest rates and persistent disinflationary pressures in the United States and abroad—and given what has been learned during the monetary policy framework review, refining the statement could be helpful in increasing the transparency and accountability of monetary policy. Such refinements could also facilitate well-informed decisionmaking by households and businesses, and, as a result, better position the Committee to meet its maximum-employment and price-stability objectives. Participants noted that the Statement on Longer-Run Goals and Monetary Policy Strategy serves as the foundation for the Committee’s policy actions and that it would be important to finalize all changes to the statement in the near future.

The “near future” is likely the September meeting. The most significant change to the Fed’s strategy is likely to be some flavor of an average inflation target whereby the Fed attempts to allow inflation to rise above 2% to compensate for periods of time below 2%. This differs from the current strategy in which the Fed only attempts to return to the 2% target. The practical implication of this policy shift is that the Fed will keep policy easy for longer than was the case in the last recovery. 

Although the Fed had an understandably dour outlook, they are not inclined to change the forward guidance just yet:

With regard to the outlook for monetary policy beyond this meeting, a number of participants noted that providing greater clarity regarding the likely path of the target range for the federal funds rate would be appropriate at some point.

This is somewhat surprising given the outlook for inflation and unemployment; the Fed would obviously like to accelerate the recovery. That said, it appears that they still have yet to decide what shape such guidance would take:

Concerning the possible form that revised policy communications might take, these participants commented on outcome-based forward guidance—under which the Committee would undertake to maintain the current target range for the federal funds rate at least until one or more specified economic outcomes was achieved—and also touched on calendar-based forward guidance—under which the current target range would be maintained at least until a particular calendar date. In the context of outcome-based forward guidance, various participants mentioned using thresholds calibrated to inflation outcomes, unemployment rate outcomes, or combinations of the two, as well as combinations with calendar-based guidance.

It may have been too much to expect the Fed to both change its policy strategy and its forward guidance at the same meeting. This extension was interesting:

In addition, many participants commented that it might become appropriate to frame communications regarding the Committee’s ongoing asset purchases more in terms of their role in fostering accommodative financial conditions and supporting economic recovery.

As if it was a surprise that asset purchases had already evolved past their initial rational as supportive of market functioning. In the press conference that followed the July meeting, Federal Reserve Chair Jerome Powell said as much:

And we’ve always said, though, that we understand, accept, and are fine with the fact that—that those purchases are also fostering a more accommodative stance of monetary policy, which would tend to support macroeconomic outcomes. So it’s doing both, and—and, you know, we’ve understood that for some time. It’s not—the programs are not structured exactly like the—the QE programs were in the last—in the last financial—in the aftermath of the last financial crisis. Those were more focused on buying longer-run securities. The current purchases are all across the—the maturity spectrum. Nonetheless, they are supporting accommodative financial conditions. I think it’s—it’s clear that that’s the case.

Look for the Fed to make more explicit what Powell has already said. Also watch for the possibility that they shift the mix of assets toward to the longer end of the curve to prove that asset purchases are more like QE than only to support market functioning.

The Fed threw cold water on the notion of yield curve control for now:

A majority of participants commented on yield caps and targets—approaches that cap or target interest rates along the yield curve—as a monetary policy tool. Of those participants who discussed this option, most judged that yield caps and targets would likely provide only modest benefits in the current environment, as the Committee’s forward guidance regarding the path of the federal funds rate already appeared highly credible and longer-term interest rates were already low.

I have argued that yield curve control was on its way at some point after the Fed embraces enhanced forward guidance. Since they have yet to make the guidance move, they weren’t going to make the yield curve control move. That said, at this point the Fed believes that such guidance alone would be sufficient to lock down interest rates. Yield curve control would be redundant in such a world. The implication is the yield curve control would only come into play if the Fed believed that forward guidance was unable to hold interest rates in the desired range.

Separately, the housing market continues to run hot with starts rebounding:

while builder confidence is now at its highest level since 1998:

Traditionally, housing is a good leading indicator for the economy as a whole; I don’t think we can ignore the possibility that the economy grows around the virus more quickly than anticipated. The conventional wisdom has fully embraced the idea that this recovery will mirror the last. That already isn’t happening.

Bottom Line: The Fed remains focused on downside risks but as of yet is unwilling to act further to support the recovery. Maybe they won’t need to.

Initial Claims Decline, Bonds Try To Sell Off

Initial unemployment claims fell below 1 million to 936,000:

There were an additional 488,622 Pandemic Unemployment Assistance claims. Continuing claims maintained its long, slow decline:

Still one of those glass half empty, half full situations. Claims continue to move in the right direction even if still above the worst of the Great Recession. But they remains at high levels, and with the enhanced benefits now expired, the fiscal cushion is limited. Moreover, we aren’t yet sure how quickly claims will decline considering the ongoing epidemic is keeping a lid on growth in many regions, the payroll protection plans has ended, and state and local governments face revenue constraints.

The standoff in Washington D.C. continues as neither side is ready to give ground. The Wall Street Journal speculates that the fight over the coronavirus support may spill over into late September:

The gulf in legislative proposals and the complicated political dynamics have prompted some lawmakers and aides to begin eyeing an alternative course on coronavirus relief: pairing the measures with legislation to keep the government funded after Sept. 30.

Congress must pass legislation by that deadline to prevent a government shutdown, and lawmakers will likely opt to approve a temporary measure that would fund the government until after the election. Coronavirus-relief measures could be attached to the stopgap bill, providing another deadline to try to force lawmakers to put together a compromise.

That seems to raise the possibility of a government shutdown in the fall…which would be a bit ugly going into the election. I am a bit surprised that the fact that we are currently going over a fiscal cliff has yet to rattle Wall Street. I imagine that we shouldn’t discount entirely the possibility that even with the fiscal cliff the economy will remain on the mend.

Wednesday, Boston Federal Reserve President Eric Rosengren gave some rather pointed comments about the economy:

While the fiscal and monetary stimulus has been significant, it cannot fully offset the economic drain caused by the public health crisis. Limited or inconsistent efforts by states to control the virus based on public health guidance are not only placing citizens at unnecessary risk of severe illness and possible death – but are also likely to prolong the economic downturn.

Very direct and ratcheting up the rhetoric from the Fed that Covid-19 still threatens the economy and there is only so much it can do to compensate for the resulting economic damage.

Bonds are selling off a bit as the market absorbs new supply:

I know, not the sell-off of the century. Roberto Perli attributes part of the move to an inattentive Fed:

This echoes my thoughts on Bloomberg earlier this week. The Fed will only let this go so far before they tighten up the guidance. This move though by itself won’t garner much Fed attention.

Bottom Line: Slow but ongoing progress in the economy that is threatened by the continuing pandemic and faltering fiscal support. Nothing here to move the Fed in any direction but easier.

A Different Way of Thinking About The Inflation Numbers

Inflation jumped higher in July as core-CPI rose 0.6%, well in excess of Wall Street’s expectation of a 0.2% gain. This surprise gain can be attributed to a pricing rebound compared to the negative prints earlier this year and a response to temporary supply constrictions. It certainly does not by itself indicate the U.S. economy is poised for a 70’s-style Great Inflation. That said, it opens up the possibility that disinflationary forces are less severe than initially perceived at a time the Fed has embraced the fight against disinflation.

The pop in core-CPI was as impressive as the earlier collapse:

The gains were fairly broad-based. Among the major categories, only food and piped gas services posted negative month-over-month numbers. Core goods gained sharply:

As did services less rent:

Even shelter has firmed in the last three months:

The conventional wisdom is that this is nothing more than a short-term bounce from earlier weakness and temporary supply constraints. Fellow Bloomberg Columnist Coner Sen says:

But what’s really happening is that pandemic-related supply and demand dynamics are distorting price signals in the short term. While we might get hot inflation prints for a few months, we should expect them to get back to normal as production does the same.

Coner does not expect the numbers to become the inflation of a failed state, and rightly so. To get interesting inflation like that, you need to see wage inflation of a similar magnitude. We just aren’t anywhere that point; that’s a whole different dynamic.

Instead of sustained high inflation, Coner says we return to “normal.” What exactly is “normal”?  This question has me thinking that the underlying inflation forces are stickier than the Fed perceives them to be. Indeed, survey-based inflation expectations have actually firmed in recent months:

And recall that former Federal Reserve Governor Daniel Tarullo questioned the strength of our understanding about inflation:

The substantive point is that we do not, at present, have a theory of inflation dynamics that works sufficiently well to be of use for the business of real-time monetary policy-making.

When Tarullo wrote this, he was doing so at a point in time when we were trying to explain why inflation was not rising as fast as we anticipated. The logic works both ways. We could run into a period of time when inflation does not fall as much as anticipated. Or put it in a different way: In February we all came to the conclusion that the Phillips curve was dead and could not be a useful guide to inflation. Now, just a few months later, we are all using Phillips curve logic to confidently predict that disinflation is a major threat.

But if the Phillips Curve is flat:

Then as we shouldn’t conclude that low unemployment will drive substantially higher inflation, we also shouldn’t conclude that high unemployment will drive substantially lower inflation.

So the way of thinking about inflation is not to look at the extremes, but to think of it as sticky at 2% or a notch below. That’s enough to keep the Fed focused on the possibility of disinflation even if that possibility is less of a risk than we like to believe given the unemployment rate. The Fed has said absolutely, for sure, don’t even ask, that they aren’t thinking about thinking about thinking about raising interest rates anytime soon. Instead, all of the Fed’s energy is currently direct at looking for ways like yield curve control to boost the effectiveness of monetary policy and pushing for more fiscal stimulus to the point where they can’t raise interest rates because they have basically committed to not offsetting that stimulus.

If you have inflation sticky near 2% and a Fed that is dead set to holding rates at zero for as far as the eye can see, you are looking at a sustained period of real interest rates at nearly -2%. That should be friendly for real assets, especially if you get another blast of fiscal stimulus right before a Covid-19 vaccine hits the market. 

Bottom Line: The inflation numbers aren’t telling us hyperinflation is on the way, but at the same time maybe the negative inflation earlier year this might not have been signaling deflation. Maybe the reality is much more boring and inflation is stuck in its recent range. Even that though has implications when the central bank remains positioned to fight disinflation.

Fiscal Follies Continue

If You Don’t Have Any Time This Morning

Incoming data still reflects the push-pull dynamics of the shutdown and reopening; we don’t have a clear picture of the growth trajectory after those dynamics play out. Fiscal policy in the U.S. is a mess.

The Dollar

I noticed this via Reuters:

The dollar is at its most oversold level in over 40 years, investment bank Morgan Stanley said on Friday, adding it had now shifted from its dollar-bearish stance and turned “tactically neutral” on the U.S. currency.

I want to make clear that there are two separate dollar stories circulating. One story is that the dollar is less attractive due to anticipated growth differentials between the U.S. and other nations, particularly Europe. Perfectly reasonable but note that that story can take on a life of its own until the dollar is oversold; Morgan Stanley apparently believes we have reached that point, at least in the near term. The fiscal follies in the U.S. hint that maybe this bet has more room to run, but be wary that Democrats and Republicans eventually reach a deal.

The second story is that you should sell the dollar because it is about to lose its status as a reserve currency. All I am going to say on that point is that I have heard a version of that story every few years since I was in grade school (don’t ask how exactly how long; long enough) and yet the dollar seems to only grow in importance. Recall that just a few months ago, there was a dollar shortage that required the Fed to open up swap lines with global central banks.

I would suggest leveraging your dollar negative bets, should you be inclined, on the first narrative rather than the second.

Key Data

The highlight of the week was the employment report. The U.S. economy added 1.8 million jobs in July, a surprisingly strong number given still high initial unemployment claims, weak ADP report earlier in the week (a gain of only 167k private sector jobs), and Census Pulse data that suggested a downturn in the jobs market. The combination is somewhat puzzling. I suspect the establishment report is still being push and pulled by the dynamics of the sudden shutdown and the initial reopening and has yet to reveal where the labor market stands after those dynamics have played out. The other data I think is signaling that we are close to seeing that process conclude and will soon settle into a slow grow trajectory.

The headline unemployment rate fell from 10.9% to 10.2% while the broader U-6 measure of unemployment declined more sharply, falling to 16.5% from 18.0% in June. On the other hand, workers are not streaming back into the labor market yet. Labor force participation edged down 0.1 percentage points to 61.4%, 2 percentage points lower than prior to the pandemic, a decline that helps hold down the unemployment rate. Watch of course how this number evolves going forward. Now that the enhanced unemployment benefits have expired, some persons currently not in the labor force may reenter (of course it is not clear that there are jobs available for them). Also, widespread school closures and childcare issues may pull some working parents from the labor market or prevent them from returning. Meanwhile, initial unemployment claims fell to 1.186 million in the final week of July while continuing claims maintained their slow decline.

Early in the week, the Institute of Supply Management release solid reports for both manufacturing and the services sector of the economy. Note though that the data is bouncing off the bottom, and a diffusion index like these should get a solid pop when the economy goes from “closed” to “mostly open.” Also note that the improvement in most components has not yet translated into similar gains in the employment component . This again suggests a weak employment picture after the start-stop dynamics end.


Federal Reserve officials reiterated some common these last week. Dallas Federal Reserve President Robert Kaplan said increasing Covid-19 infections are weighing on the recovery and more fiscal support is critical. Cleveland Federal Reserve President Loretta Mester echoed these themes. Federal Reserve Vice Chair Richard Clarida was fairly optimistic in a CNBC interview:

“It will take some time I believe before we get back to the level of activity we were at in February before the pandemic hit,” he said. “My baseline view is that we could get back to the level of activity perhaps towards the end of 2021. There are a lot of moving parts with the virus and the global outlook.”

That said, his forecast was dependent on the current stalled fiscal support talks and, curiously, the view that the U.S. economy has suffered little permanent damage. The still high level of initial unemployment claims, however, suggests otherwise.

Boston Federal Reserve President Eric Rosengren attempted to defend the struggling Main Street Lending Program at a Congressional Oversight Panel. The program has seen limited use although Rosengren expects interest to rise if the economy worsens. I find this somewhat distressing as it suggests the Fed no longer hopes the program will accelerate the recovery and instead is only a backstop in case the economy slides further. That said, I never really had high hopes for the program in the first place. Fundamentally, to survive this crisis and thrive on the other side, many firms need grants not loans. A useful alternative would be zero rate long term loans with weak underwriting conditions that expected a high rate of business failures. But loans that just saddle a firm with additional debt that they will struggle to repay in the future are just simply not that attractive.

Upcoming Data

A fun week ahead. It starts off a bit slow with JOLTS for June (more of a data nerd report, so I like it but I am not convinced it is a market mover) on Monday and PPI on Tuesday. Thursday is the usual initial claims data. Friday it gets more interesting. We get retail sales for July; expectations are the core sales continue to improve and rise 1.6% over the previous month. But how much value is this data now that enhanced unemployment benefits have ended? Industrial production is expected to gain 3.0% in July over June. Productivity growth for Q2 is expected to come in at 1.5%. We also get preliminary Michigan sentiment numbers, expected to ease to 72.0 in August from 72.5 in July. For the most part, the data flow for July will likely reveal the impact of the rebound from the initial shutdowns; probably more important is the August data in which we will have a better sense of the likely growth trajectory going forward.

Fiscal Policy Update

Talks between Democrats and Republicans broke down last week leaving the economy adrift without the substantial fiscal support that has kept the lights on for many households. President Donald Trump responded with a series of executive orders intended to force through additional support by decree and force Democrats back to the table. It is not clear, however, that the orders will provide much support for the economy. I think the best bet is that they will provide little benefit anytime soon.

One order directs $44 billion of disaster relief funds to federal unemployment benefits, providing an additional $300 per week compared to the existing $600. It is not yet clear when or if these benefits will ever see the light of day (see Jack Balkin here). To utilize the benefits, states need to contribute another $100 per week of benefits; given that states were already struggling with a revenue downturn, it is not clear when or if they will be able to support the match. In addition, the order includes a cutoff that limits the additional benefits for those earning $100 a week or more from regular UI benefits. In large part, states lack the capacity to fine tune unemployment benefits in such a way and may opt out knowing that the money might be gone by the time they remake their systems. It thus seems unlikely that this money would arrive anytime soon and even if it did it only provides benefits for roughly six weeks.

A second order defers payment of the worker portion of the payroll tax from September 1 to December 31. “Defers” is just what it sounds like; the tax will still be owed next year. Trump promised to create tax relief if re-elected, but of course can’t do that unilaterally. So for the moment firms are caught in legal limbo. Do they stop collecting the tax from workers knowing that they could be liable for the tax at some point in the future? I would think that most firms continue to collect the tax. Moreover, it is not particularly effective stimulus as it does nothing to address the problem of people without jobs. Finally, it opens up a nasty political problem because the payroll tax funds Social Security and Medicare (notice I said political problem; it’s just an accounting issue at a certain level).

A third order claims to extend the eviction moratorium, but doesn’t really and directs agencies to fund funds or find other mechanisms to help prevent foreclosures, if possible. A fourth order continues the zero-interest rate interruption of student loan payments until the crisis is over. This probably isn’t legal but it is not evident who would challenge the order

It thus seems like these orders are a lot of smoke but not much fire. The only potentially meaningful part, the extension of unemployment benefits, has a limited lifespan and may never really get off the ground, certainly not in a timely fashion. For the moment at least we need to recognize that the economy has lost a key part of support and still faces a dire need for state and local aid.

Bottom Line:  The U.S. economy continues to bounce off the bottom; we don’t have a good sense of the ultimate growth trajectory. The fiscal setback is a red flag for the economy; the Fed can’t compensate entirely if the Federal government pulls back from supporting the economy.  At this point, the U.S. looks positioned to repeat the fiscal mistakes of the last recovery. 

It’s All About Fiscal Policy Right Now

If You Don’t Have Any Time This Morning

The Fed will do what it can to support the economy, but if fiscal policy stumbles, the Fed will have a hard time picking up the slack. And fiscal policy might be about to stumble badly.

Key Data

It’s All About Fiscal Policy Right Now

The second quarter GDP report was, as expected given the sudden stop of activity associated with efforts to contain the pandemic, quite dismal. GDP fell 9.5% during the quarter or 32.9% on an annualized basis, a bit better than market expectations of -34.1%. Consumer spending drove the decline which of course speaks to the nature of the specific shock of the shutdowns early in the quarter. The decline of nonresidential investment was consistent with that of the last recession; inventory reduction and residential investment extended the decline.

While consumer spending declined for the quarter overall, spending picked up sharply in May and June. This, along with inventory rebuilding and gains in housing (see this on lumber prices), helps set the stage for third quarter bounce in GDP growth. Still, gains will fall short of those needed for a complete recovery. Note the substantial gap, for example, of current levels of consumer spending relative to the pre-Covid trend. The inability to fully restart some sectors of the economy such as leisure and hospitality will put a lid on the near-term recovery and limit the extent any third quarter gains will be transmitted into the fourth quarter. The crucial issue is not so much that second quarter output collapsed; it’s really about where we end up at the end of the third quarter and how quickly the economy can grow from there. Until a widely available vaccine becomes available, we need to assume slow and choppy growth and a protracted period of high unemployment is the most likely path forward.

PCE inflation rebounded in May and June; annualized, core-PCE grew at a 2.5% rate in June while the year-over-year rate is 0.9%. The overwhelming expectation is that the last two months are something of an anomaly and that the ongoing recession will weigh on inflation for the foreseeable future. I think this has to be the baseline expectation; I also think we should watch for the possibility that income support helps ease the disinflationary pressures relative to those normal associated with protracted double-digit unemployment.

Initial unemployment claims have flatten out around 1.4-1.5 million while continuing claims edged higher ; the lack of improvement in these data suggest the economic recovery stalled out in July and argues for the importance of extending enhanced unemployment benefits.


The FOMC concluded a two-day meeting last Wednesday; my full reaction is here. From the statement and the press conference, my main takeaways are:

  1. The Fed knows that there is not a tradeoff between the economy and the virus.
  2. The Fed very much wants continued fiscal support for the economy given the inability to contain the virus.
  3. The Fed understands that they have limited near-term power to offset a fiscal retreat.
  4. The Fed expects to keep interest rates low for years and don’t want you asking about when that’s going to change.

Minneapolis Federal Reserve President Neel Kashkari gave an interview to CBS news Sunday. Some interesting stuff here. For example:

KASHKARI: Well, the thing that surprised me the most economically, we knew the GDP would be very low with 20 million Americans still out of work, you know, the economy is reeling. There’s one bright spot that I saw, though. The US personal savings rate has taken off. Before the crisis, it was around 8%. Now it’s around 20%. Now, let me tell you what’s going on. Those of us who are fortunate enough to still have our jobs, we’re saving a lot more money because we’re not going to restaurants or movie theaters or vacations. That actually means we have a lot more resources as a country to support those who’ve been laid off. And so while historically we would worry about racking up too much debt, we’re generating this savings ourselves. That means Congress has the resources to support those who are most hurting.

Kashkari attributes the rise in the savings rate to spending collapse among those who did not lose their jobs. That savings, he argues can be funneled into safety net spending. I am clearly not the person who is going to argue against fiscal stimulus here, but I find this particular logic somewhat strained. I don’t think the savings rate necessarily justifies the fiscal spending in this manner; the fiscal spending drove up incomes and was a factor in driving up the savings rate. I see this as a reminder that we should be careful in assigning causality to accounting identities.

Kashkari also adds this:

And if you look over the long term, our inflation has been very low. Inflation continues to be low. Inflation expectations continue to drift lower.

I am kind of wondering where he is seeing inflation expectations drift lower; the survey measures have firmed up since the recession began. And we know that market-based TIPS measures have also firmed in recent weeks. I am not really worried about inflation, but I am still watching for signs like this that policy makers are so entrenched with the idea that inflation can’t be a problem that they kind of miss any inflationary signals.

Separately, Nick Timiraos at the Wall Street Journal writes that the Fed will soon make a substantial policy shift:

The Federal Reserve is preparing to effectively abandon its strategy of pre-emptively lifting interest rates to head off higher inflation, a practice it has followed for more than three decades.

Instead, Fed officials would take a more relaxed view by allowing for periods in which inflation would run slightly above the central bank’s 2% target, to make up for past episodes in which inflation ran below the target.

Remember, you heard it here first. From my Bloomberg column two weeks ago:

For the Federal Reserve, this time really is different. Having learned a hard lesson in the last recovery — don’t tighten monetary policy too early — the central bank is leaning in the opposite direction. In practice, that means the Fed will not just emphasize actual inflation over forecasted inflation, but will also attempt to push the inflate rate above its 2% target. It’s a whole new ballgame.

Upcoming Data

Employment week!

ISM manufacturing numbers for July arrive Monday; market participants expect it to edge higher to 53.6 from 52.6. In contrast, the ISM services number (Wednesday) is expected to retreat 57.1 in May to 55.0; there is a solid possibility that the decline might be more pronounced due to the rising number of Covid-19 cases.

Wednesday we also see the ADP report with an expected gain of 1,500k relative to 2.369k rise in June. This will potentially provide a preview of Friday’s employment report. Currently, Wall Street expects a continuation of recent trends with a 1.65 million gain in jobs and a decline of the unemployment rate from 11.1% to 10.5%. In contrast, high frequency Census data suggests a job loss, which would also be consistent with the ongoing high pace of initial jobless claims and slowing activity in the regions most heavily impacted by Covid-19.


The focus of the week is fiscal policy. A key reason that the economic damage of the Covid-19 pandemic is less severe than the sharp drop in GDP would suggest is that Congress threw a bunch of money at the problem including a critical enhanced unemployment benefit of an additional $600 a week. With Senate Republicans flailing to respond to a House relief package passed months ago, the benefit expired last week. This is not good and, quite frankly I am surprised given that the GOP electoral prospects will not be helped by the ongoing delays.

The Wall Street Journal reports that Democrats have yet to budge on their demand that the $600 payment continues:

House Democrats led by Speaker Nancy Pelosi want any economic-relief package to include a long-term extension of the enhanced unemployment benefit, arguing the extra funds have been a critical support to those who lost their jobs amid the pandemic. The White House and Senate Republicans, however, want to trim that additional payment, saying in some cases people are being paid more to stay at home than if they returned to work.

House Leader Nancy Pelosi suggested tying the benefit to the unemployment rate such that it would decrease as the economy healed. Great idea; an automatic stabilizer would end the need to have this fight repeatedly. Democrats are also pushing for substantial state and local aid and a public health strategy to contain the virus.

Democrats are digging in their heals while Senate Leader Mitch McConnell has a challenge to move anything without their support. Via the New York Times:

But at least 20 Senate Republicans are unlikely to support any additional spending, party leaders have acknowledged, in part because of concerns over the level of spending and its effect on the national debt. Under a $1 trillion plan Republicans unveiled on Monday — a narrower proposal than the Democrats’ plan — a number of provisions, including the $600 weekly federal unemployment benefit, would be severely curtailed.

This seems like a very bad place for McConnell. The longer this continues, the worst will be the economic damage. The worse the economic damage, the more the White House will push for a deal, and the greater the pressure for McConnell to make deal that without the full support of Senate Republicans.

I don’t entirely know how this gets resolved in the near term. My instinct continues to be that the end result will be something with broad contours that look closer to the Democratic proposal than the $1 trillion that many Republican Senators have their hearts set on.

Bottom Line: Continued income replacement is crucial to sustaining the recovery. With the economy still producing a steady stream of job losses as indicated by initial jobless claims and still restrained by the ongoing pandemic, a failure to soon enact a new fiscal response would threaten the recovery. I still think, however, the longer this drags on, the larger the ultimate package will be.