When I began blogging under Mark Thoma’s renowned Economist’s View blog I really didn’t know where it would take me. Mostly I have treated the blog as a commitment device. For example, one of my responsibilities at the University of Oregon has been outreach, including countless public speaking events (chambers of commerce, continuing education events for professional organizations, Rotary clubs, etc.) across the state of Oregon. The regular blogging focused on the Federal Reserve, and by extension the U.S. economy, very much improved my performance as a speaker and my service on the Oregon Governor’s Council of Economic Advisors and the Oregon State Debt Policy Committee. And I came to the realization last week during a very well-attended Zoom talk with 250 participants that it was a hit because I was the most interesting way (or least painful?) to complete some continuing education credits. That was great for the group and great outreach for the University. The blogging and the associated connections made over the years certainly helped make the outreach more accessible and enjoyable for the audience.

After more than 15 years under my belt I have been blogging for so long now the genre has come full circle. The early, exciting days of blogging gave way to competition by savvy media outlets and then the more succinct Twitter while my product pretty remained the same…different platforms, experimentation with newsletter versions, and a heavy Twitter presence but still largely the same. Blogging has since made a comeback in the form of the more-easily monetizable Substack, but having never taken a break from the genre, that doesn’t feel new to me.

My wife would often ask me why I was working until the early hours of the morning for “free,” to which I would reply because I enjoy it and it improves my work. Still, over the years the blog, which I am proud to say has grown to over 4,000 subscribers, has also driven a handful of consulting opportunities in my direction. A couple of macro-related legal issues, a few out-of-state speaking engagements, etc. Nothing big or regular or on which I depended for income, and although I never sought out those opportunities, I always recognized that another outcome of the persistent blogging was that it created a plan B. This was always a bit reassuring.

What’s the point of this long story? It is time to try something different with this material. I am still with the University doing teaching, advising, and outreach but have also accepted a position as Chief U.S. Economist with SGH Macro Advisors, a macro policy research firm, where I will continue to provide Fed Watch commentary as I have through all these years. I am very excited about this opportunity and where it might lead.

The impact for readers of this blog is that the material will be re-platformed now through SGH Macro Advisors. If you are a subscriber to the blog, you will receive a separate email notifying you of this change and encouraging you to continue to enjoy my work. I look forward to seeing you at SGH.

To subscribe, or for queries, please click here: Contact SGH Macro Advisors

If You Don’t Have Time This Morning

Generally upbeat manufacturing and services survey data will reveal the underlying strength of the economy even under the weight of the pandemic. Still, the sizable employment gap will leave little doubt that the Fed will not be removing accommodation anytime soon.

Vaccine Update

As of Sunday, Bloomberg estimates that the U.S. has delivered 30.5 million doses of vaccine and the rate of vaccination now exceeds 1.3 million per day. Meanwhile, the number of new cases is falling quickly, down 40% from the peak, although concerns remain about the spread of new variants.

Recent Data and Events

The U.S. economy grew at a 4% pace in the final quarter of 2021, a notch below expectations for a 4.2% gain. Consumption contributed a meager 1.7 percentage points of the gain as the pandemic weighed on household spending. Fixed investment contributed 3.02 percentage points, down from the 5.39 percentage point contribution of the third quarter but still solid. Government spending, particularly at the state and local level, dragged down growth by 0.22 percentage points. Net exports subtracted 1.52 percentage points; this recession is unusual in that the trade deficit rose as the shift into goods spending supported imports.

The hit to consumer spending occurred in the latter part of the quarter. Expenditures were down again in December, falling 0.6% (real, 0.2% nominal):

The weakness is primarily attributable to goods spending which had surged above trend early in the pandemic and has now softened:

We don’t know yet if goods spending will mean revert as the economy normalizes. We do know that services spending will accelerate once the pandemic comes under control. Personal income rose 0.6% (nominal, 0.2% real), bolstered by rising wages and salaries and transfer payments. Wages and salaries now exceed the pre-pandemic peak:

Top-line income will see further support in January from December’s fiscal support package. The economy still faces a supply constraint due to the pandemic with households locked out of certain components of services spending. As a consequence, income growth is transferred in part to savings. The saving rate rose from 12.9% to 13.7% and my estimate of the stock of excess savings accumulated during the pandemic rose to $1.6 trillion:

This is money floating around to support spending later this year or asset prices.

Inflation was stronger for the month but the Fed will view this as transitory. Year-over-year core inflation remains an anemic 1.5%:

New single-family home sales were a notch higher and look to be reverting to the pre-recession trend:

Note that in contrast to the last recession, new home prices are rising:

If you are a forced to sell into this market, you are selling into strength rather than weakness. New orders for core capital goods remain on an uptrend:

The sector continues to show surprising strength very inconsistent with recessions of the past; we should see that strength continue more broadly in manufacturing surveys this week. For a teaser, note that the Chicago PMI for January came in at 63.8, up from 58.7.

Upcoming Data and Events

This is the typically busy first week of the month. We begin Monday with the Markit and ISM manufacturing surveys; both are expected to show that this sector of the economy entered 2021 with substantial momentum. This should also be evident in the service sector reports released later in the week. Altogether, these surveys should reveal that the economy is well-positioned for solid growth once the pandemic comes under control. That said, employment data – the ADP report on Wednesday, initial unemployment claims on Thursday, and the employment report on Friday – are expected to show only modest improvement over previous releases. The weakness should still be largely concentrated in the sectors most impacted by the winter wave of the pandemic and the associated restrictions on activity. I will be focused on hiring in the private sector excluding leisure and hospitality:

Regional Fed presidents will be visible throughout the week with comments from Cleveland Federal Reserve Bank President Loretta Mester, St. Louis Fed President James Bullard, Philadelphia Fed President Patrick Harker, Chicago Fed President Charles Evans, and San Francisco Fed President Mary Daly.

Fed Speak and Discussion

The discussion at last week’s FOMC must have shut the door hard on any premature tapering talk. Note these comments by Federal Reserve Bank of Dallas President Robert Kaplan via Bloomberg:

 “I don’t want to associate or even think about associating a time frame with that,” he said Friday during a virtual forum hosted by the North Dallas Chamber of Commerce. “I’m going to be very careful as I monitor the economy this year to see how the economy unfolds, to be patient, and more importantly, not to be rigid or pre-determined in judging when we actually meet that.”

Recall that just a few weeks ago, Kaplan was eagerly anticipating the tapering discussion. Via Reuters:

“We should be as aggressive as we can be while we are in the teeth of this pandemic, until we are convinced that we have weathered this pandemic,” Kaplan said in a virtual town hall event. But “later this year, my own view is, we should at least be having an earnest discussion about when it’s appropriate to taper” the Fed’s asset purchase program.

The Fed’s goal is to avoid another repeat of the 2013 “taper tantrum” and I sense internal pressure on presidents to get with the program. No more loose talk about the timing of the tapering discussion or the actual tapering.

Federal Reserve Chair Jerome Powell appears convinced that the Fed can accomplish the lessening of policy accommodation when the time comes without spooking financial markets. From last week’s press conference:

And when we see ourselves getting to that point, we’ll communicate clearly about it to the public. So nobody will be surprised when the time comes. And we’ll do that well in advance of actually considering what will be a pretty gradual taper… Yeah, so you know, I was here — we had all the same questions back after the global financial crisis. We raised interest rates, we froze the balance sheet size, and then we shrank the balance sheet size. So there’s no reason why we won’t be able to do that again. In fact, we learned a lot from that experience. And, you know, we understand as we understood then, but even more so we understand that the that the way to do it is to communicate well in advance, to do predictable things, and to move gradually. And that’s what we’re going to do. We’re going to be very transparent.

Shorter Powell: We learned during the last cycle how to remove accommodation. We aren’t at that point yet, but when we get there, it will be communicated well in advance, transparently, and, importantly, the actual change will be “pretty” gradual. 

In practice, the Fed most likely won’t have data sufficient to justify a tapering discussion until deep into the third quarter. If so, Kaplan’s earlier prediction will be accurate in that the Fed will have that discussion before the end of the year. Until that data arrives, however, the Fed will continue to avoid public speculation on any particular timing of that discussion or the actual tapering.

Separately, the Fed remains under pressure from critics who believe the easy money policy is spawning asset bubbles with the GameStop drama being the latest example of speculative excess. The Fed will strongly resist reducing financial accommodation to limit speculative behavior on Wall Street. Consider this from San Francisco Federal Reserve Bank President Mary Daly via Bloomberg:

 “I am not willing to pull that bridge away and injure, in my judgment, the livelihoods of people — because they don’t have jobs, they don’t have income, they don’t have wage growth — simply to ensure that some people who already have stock market wealth don’t get more.”

Daly’s point is that even if the Fed’s policy is boosting asset prices and thus wealth inequality, using that as an excuse to tighten policy risks slowing the recovery and job growth and, in the process, aggravating income inequality. In other words, reducing wealth inequality by crushing the top with tighter monetary policy does nothing to actually improve (and may worsen) the prospects of those at the bottom. The Fed does of course recognize the financial instability and asset bubbles could harm economic growth similar to that experienced in the wake of the dot.com or housing bubbles. At the moment, however, the Fed don’t see such concerns as relevant and instead remain focused on employment and inflation, both of which are far from the Fed’s goals.

Bottom Line: Although there are many reasons for optimism, the Fed will not think about tightening until the data reveals considerably more progress. My baseline expectation is that we are still many months away from that point.

Good luck and stay safe this week!

I don’t have a take on GameStop. Instead, I have a take on a GameStop take. This kind of commentary (via Axios) is floating around:

The current state of financial markets “is a feature, not a bug” of the environment created by low rates and extraordinary market intervention, says Vincent Reinhart, a 20-year staffer at the Fed who now serves as chief economist at Mellon…The Fed “has created space and created a comfort level for market participants to be aggressive in their actions and they’re being aggressive in their actions.”

The GameStop saga offers the latest opportunity to criticize the Fed for its low interest rate policy. I remind everyone that the Fed will largely ignore this criticism when setting monetary policy.

Recall what Federal Reserve Chair Jerome Powell said at this week’s press conference:

So I would just say that our — there are many things that go in as you know to setting asset prices. If you look at what’s really been driving asset prices in the last couple of months, it isn’t monetary policy. It’s expectations about vaccines and also fiscal policy. Those are the news items that have been driving asset purchases — sorry, asset values in recent months. So I know monetary policy does play a role there, but that’s how we look at it and I think, you know, I think the connection between low interest rates and asset values is probably something not as tight as people think because a lot of different factors are driving asset prices at any given time.

It is worth picking this apart. Powell attributes the bulk of the asset price move to an improving economic outlook attributable to the arrival of vaccines and supportive fiscal policy. He is clearly looking at markets overall rather than one small segment of the market or, in this case, a single stock. He does acknowledge the role of monetary policy which I would describe as two-fold. First asset purchases by the Fed drives market participants into other asset classes, supporting the prices of those assets, and second by creating an accommodative financial environment that supports the recovery more generally. When Powell says though that the relationship between monetary policy and interest rates is not as tight as perceived, he is saying that the Fed is not the proximate cause of each and every bubble of speculation that occurs in financial markets.

Powell could point toward a number of examples to remind market participants that a bubble can occur in a period of “normal” interest rates, such as the dot.com bubble of the late 1990s, that low interest rates don’t necessarily support a bubble, such as the extended zero interest rates in the wake of the GFC did not create a bubble, or that the Bank of Japan has held rates near zero for decades and not recreated the twin property and stock bubbles of the 1980s. As an aside, my inclination is the asset bubbles have more to do with investor psychology and the lure of easy money than monetary policy.

The Fed takes a very clear position on this issue: The primary objective of policy is to meet the Fed’s inflation and employment goals and they are not going to deviate from that policy without very good reason. The accusation of creating asset bubbles is not in the Fed’s opinion a very good reason. The Fed will tend to argue that the degree of tightening necessary to prevent or deflate a bubble would almost certainly be recessionary and consequently the appropriate policy response will be to strengthen the underpinnings of the financial sector to prevent any rapid collapse in an asset price from triggering a systemic crisis.

Another issue to be considered is the role of fiscal policy and forced saving. It is often assumed that if that monetary policy creates any bubbly behavior seen in financial markets. In this cycle, however, the inability of households to purchases their usual basket of goods and services coupled with rivers of federal money has swelled household balance sheets with cash. That cash will show up somewhere and not necessarily consumer price inflation. Not all of that saving will support pent-up consumer spending, and maybe not much of it at all, which suggest that it may have minimal implications for consumer price inflation. Instead though if it remains as a level shift up in savings, it supports asset price inflation.

My instinct is that the pool of savings supports a series of asset bubbles from Bitcoin to GameStop to whatever’s next. As long as these asset bubbles rise and fall without meaningful impacts on real economy activity, I expect Fed critics will be disappointed by the Fed’s lack of interest. To be sure, small but recurring asset bubbles may eventually lead to a larger, more disruptive bubble, but I don’t think that is yet the case. The Fed will cross that bridge when it gets to it.

Still, anticipate some random Fed speak revealing concern about the Fed’s impact of asset prices. Just as some policy makers will speculate on the possibility of the early end of tapering, others will eventually suggest monetary policy needs to be more attentive to irrational exuberance. These concerns have been an on-again, off-again feature of the FOMC minutes for as long as I can remember but always limited to a minority view.

Bottom Line: The Fed will strongly resist the criticism that they are to blame for overly exuberant financial markets, particularly when that exuberance is limited to a single stock. Policy is firmly focused on jobs and inflation. For me, worrying that Fed policy runs counter to “fundamentals” never has paid off. My approach remains to try to understand the driving forces of Fed policy and accept that policy as a “fundamental.”

Wednesday the FOMC left policy unchanged as expected. That said, the modest alterations to the statement and Fed Chairman Jerome Powell’s comments made clear that the Fed increasingly sees the upside potential for later this year. At the same time, however, Powell emphasized that any talk of removing policy accommodation was premature given the inflation dynamics. Effectively Powell was bending over backward to instill credibility in the Fed’s new policy strategy. That means that even though he is bullish on the economy, the Fed will nonetheless hold the pedal to the metal. Don’t go looking for the Fed to tame asset prices with higher rates. The Fed’s focus is squarely on jobs and inflation.

The key change in the statement this paragraph in December:

The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.

Evolved into this:

The path of the economy will depend significantly on the course of the virus, including progress on vaccinations. The ongoing public health crisis continues to weigh on economic activity, employment, and inflation, and poses considerable risks to the economic outlook

The addition of vaccinations reveals the Fed is keenly aware that the pandemic will most likely be brought under control this year with the exact timing dependent on how quickly we can get shots in arms. The timing of vaccinations is thus critical to the timing and magnitude of the recovery. The exclusion of the near and medium-term guides reflects that the public health risks are really about the near-term at this point with the medium-term risk mitigated by the vaccines. Powell described the change like this:

So in the statement on the language, we dropped in the medium term it’s the rollout of the vaccine, the arrival of new strains that are more contagious and dangerous. When we were thinking medium term we were thinking scars and things like that. Nonetheless to go to your second question, as I mentioned in my opening remarks, there’s good evidence to support a stronger economy in the second half of this year. In fact, if you look as we do at a range of private forecasters, what was their forecasting in December and what’s their forecast now, right across the board much higher forecast for 2021 growth because of the on going rollout of the vaccine and CRA act getting done. There is a positive case there, but that — think of that as the sort of base case is a strong economy in the second half of the year. The language says there’s still — I forget the exact language, down size risks — we used an adjective. It was considerable risks to economic outlook. There are considerable risks of economic outlook nonetheless that is a more positive outlook and that’s how I would parse that for you.

Powell revealed that his optimism reflects that the economy is more resilient than expected:

The other thing, even conditional on that, when we say the wave in the south and west, the wave of cases this summer, I think intuitively having seen what happened in March and April, we expected there to be a significant hit to economic activity and people kind of just got on with their lives and dealt with it. It had a much smaller effect on economic activity than we expected. Then comes the fall wave which is just so much larger, very large wave as was very much forecast people going indoors, the weather all that. Even there look at the December jobs report. So big job losses and, you know, that part of the service sector, I mentioned 400,000 jobs in bars and restaurants, another hundred thousand in similar kinds of activities. If you look elsewhere, it’s not having an effect. You know, purchasing manager index, incentive index on areas of the economy not really directly exposed to the pandemic in their economic activity, they’re doing okay. They are. Housing is a great example. You know, the way the housing industry worked when you buy a house there was a lot of in person contact.

Note Powell’s take on the December jobs report. As I have said before, the private job weakness was very sector specific. Private employment excluding leisure and hospitality was up 403k jobs and the three-month average was at 468k jobs. It was a good report that revealed the resilience of the economy. Powell sees that and is buying the story that the pandemic is the most critical impediment to the economy and once we contain the pandemic the economy can bounce back quickly:

I would just urge that — I know people are working hard on that, but that is really the main thing about the economy is getting the pandemic under control, getting everyone vaccinated, getting people wearing masks and all that. That’s the single most important economic growth policy that we can have.

Despite a generally bullish outlook, Powell steadfastly refused to give any indication that the Fed intended to talk about tapering or hiking rates anytime soon. He leaned heavily on the Fed’s new policy strategy to defend its position. The Fed remains too far away from reaching its goals to think about removing accommodation. On jobs:

In a world where almost a year later we’re still almost 9 million jobs at least, that’s one way of counting can be counted higher than that, short of maximum employment, people out of the labor force, the real unemployment rate is close to 10 percent if you include people in the labor force, it’s very much appropriate that monetary policy be highly accommodative to support maximum employment and averaging two percent over time.

And:

…the reason we talk about inequality and racial inequality in particular, it goes to our job which is to achieve maximum employment which links up with we want the jobs to be as high as it can be, everybody can take part and put their labor in and share in the prosper in our economy, that’s what we want.

Moreover, Powell pushed back hard on inflation concerns. He emphasized that the Fed would not be fooled into an inflationary scare attributable to either base effects or the initial phase of a rebound. Importantly, he very carefully explained that the economy has been locked into a disinflationary dynamic that will not be easy to change. For example:

…it helps to look back at the inflation dynamics that the United States has had for some decades and notice that there has been, you know, significant disinflationary pressure for some time for a couple of decades. Inflation has averaged also than two percent for a quarter of a century and the inflation dynamics from the flat Phillips curve and low persistence of inflation changes over time. It evolves constantly over time but don’t change rapidly. It’s very unlikely anything we see now would result in troubling inflation. Of course if we did get sustained inflation level that was uncomfortable, we have tools for that. It’s far harder to deal with too low inflation.

The Fed is not afraid of inflation getting out of control. The Fed is more afraid of making the mistakes of the last recovery and withdrawing support for the economy too early. The Fed will not hike rates until inflation exceeds 2% on a sustained basis. This is not the forecast of inflation, this is actual inflation. The Fed expects us to take these promises seriously and stop worrying about rate hikes until something interesting happens on the inflation story. And stop worrying about tapering until we see some data confirming the growing optimism for this year’s outlook.

The Fed will also not let financial stability fears deter it from its inflation and employment goals. This topic has gained renewed attention with the GameStop surge, a topic that Powell deferred from commenting on directly. With regards to financial stability, the issue is not just one stock:

 So on matters of financial stability, we have a framework. We don’t look at one or two things. We made the framework public after the financial crisis so it can be criticized and held accountable. We look at say set prices and look at leverage in the banking system and non-banking system and corporates and households and we look at also funding risk. If you look at across that range of readings, they’re different and we monitor them careful. Overall it’s moderate. Our overall goal is to assure financial system itself is resilient to shocks of all kinds and it’s strong and resilient and includes not just banks but money market funds and different kinds of non-bank financial structures as well.

I take this to say that even if assets were broadly overvalued (yes, I know, many of you think that is the case), the Fed’s concern would heighten only if the overvaluation looked to be a factor in creating a systemic risk to the financial system as a whole. That seems like a pretty big hurdle to clear anytime soon. If having failed to get the Fed to reduce accommodation on the economic outlook market participants think a financial stability story can achieve the same goal, it won’t.

Bottom Line: Powell is trying to do two things. First, recognize the improving economic outlook. Second, make clear that this improvement has not yet impacted the Fed’s expected policy path. The new strategy is very clear that forecasts alone are not sufficient to justify reducing policy accommodation. Forecast-based inflation fears failed the Fed in the last recovery and they expect the same would happen now. As a result, the focus is squarely on results. Considerable progress toward goals needs to be made before tapering. Sustained inflation needs to occur before raising interest rates. The Fed will continue to pound on this message. Also, Powell is not impressed with anyone’s concerns about asset bubbles. It’s all about inflation and jobs.

Note: The Powell quotes are from an unedited transcript and may have some grammatical errors.

If You Don’t Have Time This Morning

The Fed will hold policy steady this week while Powell downplays tapering talk. FOMC preview below.

Vaccine Update

As of Sunday, Bloomberg estimates that the U.S. has given 21.1 million doses of vaccine have been delivered while the rate of vaccination now exceeds 1 million per day.

Recent Data and Events

Fairly slow week for data overall but still a handful of notable releases. The housing market continued to power forward in December:

Single family starts pushed further above the pre-pandemic trend:

For the year, starts were just over a million units compared to 893k in 2019, meaning that strong starts later in the year more than compensated for the slowdown last spring. It would not be surprising to see the pace of starts moderate somewhat from December’s 1.34 million units now that last spring’s hole is filled but the sector overall remains supported by demographic trends. In other words, don’t confuse any moderation with sectoral weakness.

The IHS Markit Flash PMI for January indicates the US economy jumped out of the gate in 2021:

Adjusted for seasonal factors, the IHS Markit Flash U.S. Composite PMI Output Index posted 58.0 in January, up from 55.3 in December. The private sector seemed to regain growth momentum at the start of 2021, as the pace of increase quickened to the second-fastest since March 2015.

At the same time, private sector businesses signalled another monthly increase in new business. That said, the overall rate of growth eased from that seen in December, as service providers indicated a slower expansion in new orders following a rise in virus cases and greater restrictions on business operations. Nonetheless, the upturn among manufacturers accelerated and was the steepest since September 2014.

On inflationary pressures, the report had this to add:

A number of firms were able to partially pass-on greater cost burdens, however, as the pace of charge inflation quickened to a steep rate. The impact was less marked in the service sector as firms sought to boost sales, but manufacturers registered the sharpest rise in selling prices since July 2008.

I would not read any monetary policy implications into these inflation anecdotes just yet. One-time price adjustments in a subset of goods does not qualify as inflation. It will not be interesting inflation until it becomes a self-sustaining process across a wide spectrum of consumer goods and coincides with faster wage growth.

Initial unemployment claims edged down from 926k to 900k last week.

Janet Yellen received the unanimous vote of the Senate Finance Committee to advance her nomination as Treasury Secretary to the full Senate. She is expected to be confirmed by the Senate on Monday. As expected, Yellen pushed for administration priorities including the proposed fresh fiscal support package:

“To avoid doing what we need to do now to address the pandemic and the economic damage it’s causing would likely leave us in a worse place fiscally and with respect to our debt situation,” Yellen said.

Yellen does not seek a weaker dollar in order to gain a competitive advantage yet remained unwilling to commit to the strong dollar policy of the past. This administration looks to actively push back against efforts by other nations to manage their currencies to gain a competitive advantage in trade. This is something to keep an eye on to see how this rhetoric translates into policy. Lastly, note that the increasingly hawkish attitude toward China will carry over from the Trump administration:

“China is undercutting American companies by dumping products, erecting trade barriers and giving illegal subsidies to corporations,” Yellen said, calling the nation an “important strategic competitor.”

Fed Speak

Last week was a blackout week for the Fed ahead of this week’s FOMC meeting.

Upcoming Data and Events

The data flow picks up again this week. The highlights of the week will be the FOMC meeting (no policy changes expected) this Wednesday and the GDP report on Thursday. Wall Street expects that GDP clocked in at a 4% rate in the fourth quarter. In contrast, the Atlanta Fed GDPNow model estimates growth at 7.5% for the quarter suggesting the possibility of an upside surprise.

Other reports include durable goods on Wednesday, a traditionally volatile number that has been uniformly positive in recent months, and the personal income/consumption/prices report of Friday, much of which can be imputed from the prior day’s GDP report. We get the final January Michigan sentiment number on Friday but note that this data may have less usefulness as it increasingly reflects political divisions.

President Biden’s $1.9 trillion fiscal plan is running into headwinds in Congress with Republicans withholding support for a large stimulus so soon after December’s package. I can’t tell you how this will play out just yet; my inclination is to think the eventual support will fall short of Biden’s initial plan. I tend to focus on the administration’s effort to control the pandemic as the primary factor in the strength of the U.S. cyclical upswing this year.

FOMC Preview

The FOMC meets this week and is widely expected to hold policy constant. The statement will be fairly similar to that of December with the exception of possibly acknowledging the pandemic-induced slowdown in consumer spending this winter. The real action will be the press conference. Journalists will push Federal Reserve Chair Jerome Powell to clarify recent remarks by regional bank presidents regarding the possibility of early tapering of asset purchases. Expect Powell to hold the line set by his Board colleagues Richard Clarida and Lael Brainard: It is too early to be talking about tapering. Any talk of tapering on the part of regional presidents is just speculation of what might happen under certain particularly optimistic scenarios. The Fed though has committed to not acting on the basis of optimistic forecasts and instead will be reactive to the data. Until the data becomes more uniformly supportive of a substantially better than anticipated outcome, the Fed will dismiss talk of tapering as unwarranted.

Powell will express concern about weaker job growth this winter but will emphasize the impacts are temporary and best addressed with fiscal policy. Even though he will downplay tapering talk, I think Powell will express optimism about the latter half of the year. The accelerating pace of vaccinations and the December fiscal package greatly reduce the downside risks to the outlook. The Fed will certainly take note of improving private sector growth forecasts; it is reasonable to expect that the internal forecasts are more optimistic as well.

With any luck, a journalist will press Powell to clarify Clarida’s recent statement that the Fed will hold rates at zero until inflation been at or above 2% for a full year. This has not been formalized in the statement although Clarida has said that such a one-year memory has been chosen by the FOMC. My sense is that given persistently low inflation, the Fed leans toward the one-year rule on the expectation that inflation only modestly exceeds 2%. I don’t think they want to publicly commit to the one-year rule though because they want flexibility to address the possibility that inflationary pressures emerge more quickly than they expect.

Journalists may also question Powell on the rising longer-term interest rates. I anticipate that Powell will say higher long rates are not by themselves an impediment for the economy, are consistent with an improving economic outlook, and not indicative of a lack of credibility of the Fed’s commitment to low policy rates. Powell will emphasize the path of short-term rates reflects the Fed’s credibility. Powell would also say that the Fed will of course react to any adverse financial market moves that threaten the outlook but conditions now are very accommodative and don’t justify a policy shift.

Bottom Line: There is plenty of optimism for the latter part of 2021, but the Fed isn’t counting the chickens before they hatch.

Good luck and stay safe this week!

If You Don’t Have Time This Morning

The Fed will likely take a backseat to fiscal support and pandemic response in the coming months.

Vaccine Update

As of Monday, Bloomberg estimates that the U.S. has given 14.3 million doses of vaccine.

Recent Data

December retail sales disappointed with softness in both the headline and control groups. Headline sales have reverted to pre-pandemic trend:

While the control group remains above trend:

And, expectedly, food and drinking services continued to retreat from the September high:

Realistically, we know what will happen in this sector. Food and drinking services will be on an upswing again as we move through the winter wave of Covid-19 cases and as the pace of vaccinations accelerates in the weeks ahead. What we still don’t know is to what extent the control group fully reverts to the pre-pandemic trend or experiences a level shift upward. Given the magnitude of fiscal stimulus about to flow into the economy, the greater control over the pandemic likely this year, and the current level of overall retail sales near trend, I suspect that we will ultimately see a level shift upward in retail sales.

The retail sales numbers overshadowed the solid 1.6% gain in industrial production in December:

Auto production hovering near pre-pandemic levels:

I am keeping an eye out for any temporary weakness related to the ongoing computer chip shortage.

Preliminary consumer sentiment edged down in January to 79.2 from 80.7. I would describe this as effectively unchanged given the normal variance in the series, but you can’t make a news story on that kind of analysis. Bloomberg has this to add:

The slightly more downbeat sentiment reading signals consumers may be starting the year with less faith in the economic recovery as soaring virus cases lead to new restrictions just as inoculations become more available. Nearly 1 million Americans filed for unemployment benefits last week after the biggest jump in claims since March, a report showed Thursday.

An interesting detail is that inflation expectations have firmed since the pandemic began:

Better than weakening further as might be expected but I doubt the Fed is impressed. I think the Fed would prefer this metric trending in a range at least 25bp higher than the current level.

The Atlanta Fed GDPNow estimate for the fourth quarter is currently at 7.4%

Fed Speak

I covered Fed Speak extensively in posts last week here, here, and here. The basic story is that while some Fed presidents are entertaining the possibility of tapering later this year if the economy outperforms expectations, the consensus opinion at the Fed is that it is too early to think about tapering. The Fed won’t think about tapering seriously until the data turns decisively in a positive direction. We have to wait until the second half of the year for that to happen.

Upcoming Data and Events

As far as data is concerned, we have a slow week ahead of us with more important data not arriving until Thursday. On that day we get insights into what has been a red-hot housing market in the U.S. with December new starts and permits data. This series can be volatile but I don’t expect anything that would lead us to question the underlying direction of the data. Fundamentally, the aging of the Millennials is a demographic force underpinning housing demand. Thursday we also get the usual initial claims report; claims were higher last week at 965k as the pandemic became a renewed weight on certain sectors of the economy, in particular leisure and hospitality. The enhanced unemployment benefits included in December’s fiscal package will be helpful in compensating for this weakness; President-elect Joseph Biden’s plan is even more generous. Friday brings existing home sales; the expectation is for a slightly lower number than in November which would not be a surprise given tight inventories. Friday also brings Markit PMIs for January.

It’s blackout week for the Fed so (mercifully?) there will be no speeches to dissect.

On Tuesday, Janet Yellen will start the confirmation process with a hearing at the Senate Finance Committee. Yellen is expected to press for administration priorities and help sell Biden’s proposed $1.9 trillion support package. She is expected to say:

“Economists don’t always agree, but I think there is a consensus now: Without further action, we risk a longer, more painful recession now – and long-term scarring of the economy later.”

On the dollar, Yellen the Wall Street Journal reports she will deliver this talking point:

“The value of the U.S. dollar and other currencies should be determined by markets. Markets adjust to reflect variations in economic performance and generally facilitate adjustments in the global economy.”

Yellen is also expected to say that the U.S. doesn’t intend to weaken the dollar to achieve a competitive trade advantage but it sounds like she will fall short of advocating for a “strong dollar” policy. Possibly more important will be her degree of opposition to currency manipulation by other nations and her willingness to attempt to counter that manipulation. Finally, she will be questioned about any potential Fed-Treasury cooperation. I think she will say that she expects the Treasury and Fed will cooperate when appropriate on issues like emergency lending programs but will emphasize the Fed’s independence in monetary policy issues like interest rates and bond buying.

On Wednesday, January 20, Joseph Biden will be sworn in as the 46^th president of the United States of America.

Discussion

It’s going to be a busy couple of months as the Biden administration scrambles to undo the last four years. Aside from another fiscal support package, the most immediate mark Biden can make on the economy is to provide a coordinated, national approach to pandemic response and vaccine delivery. There are probably some easy wins here relative to the Trump administration. For instance, Biden’s goal of 100 million vaccinations in 100 days seems like under-promising with the daily average already at 850,000; I am watching for upside surprises on pandemic control in the months ahead.

Between additional fiscal stimulus and a more organized pandemic response, watch for rising estimates for 2021 growth. For instance, Goldman Sachs raised its 2021 GDP forecast to 6.6% and now expects the unemployment rate to fall to 4.5% at the end of the year. I think we will gain greater visibility on the likelihood of such outcomes as we see the competing influences of the fading winter wave, the return to warmer weather, the rise of new, more infectious variants, and expanded vaccinations. If on net cases are turning sustainably down by the end of February, the more optimistic outcomes will be increasingly plausible.

The Fed may drift into the shadows for the next few months as fiscal policy and pandemic response have their time in the spotlight. The Fed’s messaging has been fairly clear. For the time being, it is not entertaining discussion of tapering or moving forward rate hikes. There will be the occasional speaker who opines on a forecast that if realized could change the path of policy, but this is just speculation. Actual discussion of changes to the expected policy path will not happen ahead of supportive data; the Fed will be more reactive than proactive relative to past cycles.

Bottom Line: Steady monetary policy until the economy shifts gears.

Good luck and stay safe this week!

Yesterday Federal Reserve Chair Jerome Powell reiterated the comments of his Board colleagues and declared that Atlanta Federal Reserve President Raphael Bostic’s taper talk was premature. Powell:

Let me start by agreeing that now is not the time to be talking about exit. I think that — another lesson of the global financial crisis is be careful not to exit too early and, by the way, try not to talk about exit all the time if you’re not — you know, if you’re sending that signal, because the markets are listening. The economy is far from our goals. And as I mentioned a couple times, we’re strongly committed to our framework and using our monetary policy tools until the job is well and truly done. And I think the taper tantrum, you know, as you asked about the taper tantrum, it highlights, I think, the real sensitivity that markets can have about the path of asset purchases. So you know, we know we need to be very careful in communicating about asset purchases.

That should put an end to that topic for now, but note that if reporters keep asking Fed presidents about tapering, eventually they will find one who will “helpfully” provide a hypothetical example of how the Fed could get to tapering on whatever date you want. Try to keep those comments in the context that they refer to very specific potential outcomes for the economy.

The real trick is anticipating when the tapering talk will turn serious. That question gets more interesting if President-elect Joseph Biden is able to get traction with his proposed $1.9 trillion relief package. The package includes boosting the recent rebates to $2,000, expanded child tax credits, raising the unemployment insurance enhancement from $300 to $400 a week through September, $350 billion for state and local, $20 billion for public transit, and additional goodies. That is a lot more stimulus coming down the pipeline into an economy that remains impaired by the pandemic such that households are in aggregate accumulating a vast portion of the aid as savings.

The Fed will react warmly to the package, or at least it should given Powell & Co. have been begging Congress for more fiscal stimulus. The Fed will signal an intent to effectively accommodate the fiscal push; they will not engage in a fiscal offset by bringing forward rate hike expectations. As Powell notes above, the Fed does not want to send any premature tightening signals. Moreover, the Fed will not raise interest rates until actual inflation hits 2% and it likely to remain modestly above 2%. We are a long way from seeing evidence of that.

That said, fiscal stimulus should further accelerate progress toward meeting the Fed’s goals, and such progress would trigger the Fed to rethink the asset purchase program. A bigger package now suggests more progress toward recovery which in turn suggests earlier tapering. It’s kind of hard to avoid that conclusion.

So is it six months or nine months or twelve months before the Fed starts talking about tapering again? I don’t know yet although being an optimist I would lean earlier than later. Powell is apparently an optimist as well:

You know, I remember coming back to the United States from an overseas trip in — near the end of February, really being concerned about the possibility of very, very horrible outcomes in the economy and in society. And it just — so we went to work. And Congress went to work, and you know, the people who invent vaccines went to work. If you — sitting here on January 14th of 2021, we are not living that downside case. I mean, I’ll always remember the discussions we had, which were pretty scary in March and April, and you know, we were doing the best we could. But here we are now with vaccines. The population’s getting vaccinated. And you know, you’re in a situation where we could be back to the — to the old economic peak fairly soon and passing it, and we may bypass a lot of the damage that we were concerned about to low- and moderate-income people, who by the way still have very high unemployment but with the reopening of the service economy later this year, we hope, will get back out there.

So I would say I’m optimistic about the economy over the next couple of years. I really am. We’ve got to get through this very difficult period this winter with the spread of Covid. But as the vaccines go out and we get Covid under control, there’s a lot of reason to be optimistic about the U.S. economy.

One final point. If the economy picks up speed quickly, it would be reasonable to expect some upward pressure on long-term interest rates. Would the Fed try to sit on the long-end of the curve? I think it depends on the situation. I suspect the most important consideration would be if the Fed thought market participants were correctly reading the Fed’s reaction function. Back to Powell today:

…since we announced the framework in August there’s plenty of evidence that market participants have shifted their expectation in — expectations in ways that are consistent with the new framework. Surveys now show that market participants expect us not to raise rates until inflation has reached 2 percent and until the labor market is very strong indeed, and that is also consistent with our rate guidance.

If the Fed believes higher long term rates were more about longer term growth prospects than the near term path of rate hikes, it probably wouldn’t be very concerned. The Fed though would react to higher rates that were driven by an inaccurate view of Fed policy, particularly if rates moved up quickly.

Bottom Line: Powell dropped the hammer on the tapering talk. Too early to talk about it. The baseline holds, no taper through this year. Eventually though more serious chatter will emerge. The more fiscal stimulus, the sooner the progress necessary for the Fed to start thinking of policy changes.

Federal Reserve Board members today pushed back on notions of an early tightening of policy accommodation. Governor Lael Brainard gave a fairly dour assessment of the economy and emphasized that the Fed is far from achieving its goals. Importantly, she did not appear particularly excited about the outlook:

The outlook will depend on the path of the virus and vaccinations. While the number of new cases is high and rising, the distribution of multiple effective vaccines is under way. Spending on in-person services is likely to return to pre-pandemic levels only as conditions around the virus improve substantially. Most forecasts predict a significant rebound in aggregate spending this year. And there is some risk to the upside if the efficient delivery of vaccines across many jurisdictions ultimately results in a globally synchronized expansion.

Indeed, she clearly differentiates between her baseline and more optimistic outcomes:

The economy is far away from our goals in terms of both employment and inflation, and even under an optimistic outlook, it will take time to achieve substantial further progress. Given my baseline outlook, I expect that the current pace of purchases will remain appropriate for quite some time.

For Brainard, even an optimistic outlook would not quickly alleviate the inequality arising from the pandemic recession and by extension would not precipitate a need to soon scale back the accommodation provided by asset purchases. Her baseline delays changes to asset purchases even longer although “quite some time” does leave some wiggle room. She adds, however, the data dependent caveat:

Of course, the outlook is highly uncertain, and forecasts are subject to revisions—a key reason why our forward guidance is outcome based and tied to realized progress on our goals.

Regarding interest rates:

The outcome-based forward guidance communicates how the policy rate will react to the evolution of inflation and employment. It makes clear that the timing of liftoff will depend on realized progress toward maximum employment and 2 percent average inflation.

And Brainard notes that the Fed intends to look through any temporary base effects this spring:

 Inflation may temporarily rise to or above 2 percent on a 12-month basis in a few months when the low March and April price readings from last year fall out of the 12-month calculation, but it will be important to see sustained improvement to meet our average inflation goal.

What is “sustained improvement?” Vice Chair Richard Clarida added some clarity on that today. Via Reuters:

“We are not going to lift off until we get inflation at 2% for a year. … We are trying to tie our hands. We are saying we are not going to hike until we get to 2%,” Clarida told a conference held by the Hoover Institution.

I was reminded that Clarida identified the one year window in a speech last November but it was buried in more technical details that made it not stand out. But in the speech he says he is giving his interpretation of the new framework. Also, Clarida says in the speech “the FOMC chose a one-year memory for the inflation threshold that must be met before liftoff is considered” yet the FOMC statement just says “risen to 2 percent and is on track to moderately exceed 2 percent for some time” and doesn’t specify risen to 2 percent for a year. In today’s comments when Clarida says “we” it sounds like he is speaking for the Committee as if this decision has already been made. Then again, he shifts from “2% for a year” to just “2%.” Those are two different goals.

I might be overthinking this so that’s enough of the weeds for now. Let’s assume that the decision has been made that the Fed will not raise rates until inflation is at target for at least a year. The importance of Clarida’s comment is that it reveals that challenges to Atlanta Federal Reserve President Raphael Bostic’s projections that the Fed could conceivably hike interest rates in late 2022. Just follow the timeline. Right now, we know inflation is still weak. Although headline CPI rose by 0.4% in December, core-CPI grew an anemic 0.1%:

Brainard already said that we should ignore inflation attributable to base effects this spring effectively meaning the one year clock wouldn’t start at the earliest until May. Suppose that inflation hits 2% sustainably in May and  stays there through next April. Then you are in the zone of conditions supporting a rate hike in the second half of 2022, assuming of course consistent labor market outcomes. This seems to me unlikely; Bostic’s optimistic view remains a big lift given Clarida’s position that the Fed needs inflation at 2% for a year before hiking rates.

Interestingly, Clarida adds this:

 “It actually doesn’t seem lacking credibility to markets that we are going to do that.”

That tells me that Clarida thinks market participants are correctly assessing the Fed’s reaction function, at least as it pertains to rate policy. I would say that if there is a problem, it was assessing the reaction function with regards to asset purchases. The Fed has not given clear guidance on “progress toward goals,” each meeting participant has differing views on what that means, and each participant has a different willingness to opine on potential paths for asset purchases. My baseline expectation is that the asset purchase program is held in place through 2021 but that improving economic data in the summer triggers more Fed officials to speculate on the timing of tapering in 2022. If you want tapering this year, you need to see much stronger than expected data emerge this spring.

Bottom Line: With inflation low and unemployment unacceptably high, the Fed officials have little reason to signal a shift in policy. What we have seen is more speculation than signals. Real signaling will happen only when the data turn decisively more positive.

Do not become obsessed with recent Fed speak pointing in the direction of early tapering or rate hikes. The Fed is not shifting gears absent a clear justification from the data and that justification is still lacking. That said, given the changing political landscape, the accelerating pace of vaccinations, the most recent fiscal bridge, and the surplus of pent up savings, it is completely reasonable for market participants to prepare for a more widespread shift in sentiment among Fed speakers regarding the asset purchase program. That shift likely won’t happen until the second half of the year.

Let’s start with the baseline, again: No tapering this year, no rate hikes before 2023. Is there widespread support for the baseline among Fed officials? Yes. Kansas City Federal Reserve President Esther George today said:

Clearly, in the current environment where the economy continues to heal, an accommodative policy stance is appropriate. It is too soon to speculate about the timing of any change in this stance.

As of now, George lacks reason to believe the Fed needs to consider a new policy approach. That though doesn’t mean the path is fixed:

As the data come in, and the economy evolves, the public and markets should be able to adjust their expectations regarding the policy path.

That’s where I am trying to keep the focus – how might the data evolve and what does it mean for policy? Similarly, consider this from Cleveland Federal Reserve President Lorretta Mester, via Reuters:

“I think it’s very premature to think that we’re getting to the point to change our policy stance,” Mester said. “I think we have to get through this surge.”

This syncs with the general view within the Fed that later this spring – after the Covid-19 numbers are on the way down and vaccinations increasingly widespread – will be the time to revisit policy options. St. Louis Federal Reserve President James Bullard had nearly identical comments, via Bloomberg:

“We want to get through the pandemic and sort of see where the dust settles, then we will be able to think about where to go with balance-sheet policy,” Federal Reserve Bank of St. Louis President James Bullard said Tuesday during an online interview with the Wall Street Journal.

That’s the baseline story coming from the Board of Governors as well. In general, speakers tend to avoid speculating too specifically on how the Fed might react to data that deviates substantially from the forecast. In contrast, Atlanta Federal Reserve President Raphael Bostic captures the news cycle because he does entertain scenarios substantially different from the current forecast. Via an interview with the Atlanta Constitution Journal:

If (the economy) comes back super-strong, it’s warranted to start having a conversation about how we get out of our more emergency position stance in terms of providing support and get back to a more normalized asset purchase stance and interest rate stance…That conversation will happen over a longer period of time, but I think our experience has been that we should signal that we are talking about these things well before we’re planning on actually making the move. As I see evidence that the economy is coming back a bit stronger and we can pull back on the some of the stimulus that we’ve put into the economy, I am going to want to start having that conversation.

Bostic sounds as if he is expecting strong data, and he is:

I am fairly optimistic that the rebound is going to be fairly strong and I want people to understand that, if we see that strength, then the natural progression from that is to say, what’s our trajectory from that to move to a more neutral position.

Bostic’s optimism may be excessive, particularly on inflation. He has pondered the possibility of a rate hike in late 2022 which, under the Fed’s new framework, implies sustainable inflation in excess of the Fed’s target to emerge sometime in the first half of next year. That seems premature. Possible, but premature.

I wonder that Bostic has become the focus of attention because his economic outlook of surprising strength later this year matches the growing sense among market participants that the year will be much stronger than the median Fed meeting participant anticipates. Market participants are rightly looking past this winter and seeing many tailwinds on the horizon. Bostic is telling you that those tailwinds materialize, you should be expecting a healthy Fed debate about the path of policy latter this year.

It’s not really a secret that I am optimistic on the path of the economy this year. That said, I don’t anticipate it will be sometime in the third quarter before the Fed has the data to justify considering a policy shift. I would expect Bostic’s colleagues to mimic his policy outlook should that optimism be realized.

I view Bostic’s comments as very different from these by Dallas Federal Reserve President Robert Kaplan, via Bloomberg:

“My concern is if we get to 2023, for example, and we have unemployment rates below 4%, in the 3s, and we still haven’t quite reached our 2% inflation objective, I might well be supportive at that point of being accommodative or even highly accommodative, I don’t know that I’ll think it’s appropriate to be keeping the fed funds rate at zero, though,” Kaplan said.

I can put Bostic’s comments into the context of the Fed’s new policy strategy. Kaplan, however explicitly states that possibility of hiking rates before the Fed reaches the 2% inflation target. That is a very minority position on the Fed and likely requires some substantial financial stability risks that could not be managed via regulation.

Separately, JOLTS data for November showed little change in opening or quits:

The story of this report is the resilience in the job market in comparison to the last recovery

Bottom Line: Fed policy is on autopilot for now. Bostic’s comments don’t change that. Bostic’s comments, however, are a preview of what’s to come if his optimistic forecast comes to pass.

If You Don’t Have Time This Morning

Fed still on hold, increasingly contemplating potential future outcomes but around a steady baseline – no rate hikes anytime soon and no tapering this year. It’s all data dependent though. The ongoing concerns of violence ahead of next week inauguration will continue to dominate the news cycle.

Vaccine Update

As of Sunday, Bloomberg estimates that the U.S. has given 7.73 million doses of vaccine.

Recent Data

The employment report was the highlight of the week, disappointing markets with a somewhat weaker than expected 140k job loss. I am going to take an unpopular position on this report: It was actually a strong report given the circumstances and reveals the underlying resilience of the economy.

We need to look beyond the headlines on this. Unsurprisingly, leisure and hospitality accounted for the bulk of the decline with the sector loosing 498k employees. We know, however, exactly what is happening in this industry and what is going to happen after vaccines are widely distributed: It’s going to bounce back quickly. The other challenged sector is government which shed 45k jobs in December and roughly 1.3 million since the pandemic began with the largest part of that weakness in education. While it is often assumed that funding issues primarily account for the reduction in education employment, you should also consider other factors. Notably, in a Zoom-classroom world, schools need only a fraction of the usual number of substitutes. In addition, teachers have taken voluntary leaves of absences during the pandemic. When schools reopen, both categories of teachers will bounce back, as well as the ancillary staff. In short, this problem will largely correct itself (watch though for schools to face a teacher shortage as some of the pandemic-impacted employees will certainly drift into other occupations).

What does the picture look like outside of those sectors? The private sector excluding leisure and hospitality gained 403k jobs last month during the winter wave of the pandemic:

The three-month average growth rate was 468k. That growth rate alone – assuming no acceleration! – means 5.6 million jobs in 2021 not counting any bounce back in leisure and hospitality or education. The key point: Don’t use the three-month moving average of the headline number of 283k and extrapolate out to gauge expected job growth this year. That approach yields a way too pessimistic forecast.

Finally, note this story from the Wall Street Journal:

American manufacturers have gotten better at safeguarding their factory floors and containing infections of Covid-19 in their workforces. Despite the progress, they are still struggling to find enough people to staff their plants. The worker shortages are choking supply chains and delaying delivery of everything from car parts to candles just as demand is picking up…

… Companies are taking extraordinary measures to keep their lines running. At a Wisconsin dairy plant, managers have been asking employees to cancel vacation and the company recently asked a maintenance worker to help make cheese. An Ohio auto-parts maker advertised jobs on city buses and is considering adding a graveyard shift for working parents. A generator maker is so backed up on orders due to absenteeism that it has raised starting pay 25%.

There is a lot happening underneath the surface of the economy. This is not like the last expansion. Don’t let anyone tell you it is.

Fed Speak

I discussed last week’s Fed speak here and here. There is going to be a lot of chatter this week as well. The overall theme with continues to be one where policymakers emphasize the expected policy path as documented in the Summary of Economic Projections while increasingly acknowledging the growing potential for better-than-anticipated outcomes. As a reference point, consider this from Federal Reserve Vice Chair Richard Clarida via Bloomberg:

“My economic outlook is consistent with us keeping the current pace of purchases throughout the remainder of the year,” he said Friday during a virtual discussion hosted by the Council on Foreign Relations.

That’s your baseline. He also said:

Clarida allowed that his expectation for purchases could change if the economic outlook improved more than anticipated. But he also said that the economy is in a “deep hole” and that it would take time for the jobs market to heal and inflation to rise toward the Fed’s 2% goal.

“It could be quite some time before we would think about tapering the pace of our purchases,” he said.

Some participants are already thinking about it, but I will leave that alone. More importantly, it is all about how quickly the economy can rebound. If the jobs story I posited early holds, then the Fed talk about tapering will only increase.

Upcoming Data and Events

The week starts slow with the first major data release I am watching is the CPI report not coming until Wednesday. Core-CPI is expected to come in on the weak side with a 0.1% monthly gain, a number consistent with the Fed seeing no reason to change its rate forecast. Also Wednesday the Fed will release its latest Beige Book. Thursday brings the usual initial claims report. Friday we get retail sales and industrial production with the focus on the former as we look for clues about how much consumer activity slowed last month. Also on Friday is the Michigan consumer sentiment report; this report needs to be read cautiously as the results are increasingly politicized.

Federal Reserve Governor Lael Brainard, Vice Chair Richard Clarida, and Chair Jerome Powell all speak this week with the Brainard speech (Wednesday) most likely to give some new perspective. The will be plenty of Fed presidents as well.

Realistically, the focus of the week will be the ongoing political turmoil in the U.S. Covid-19 has taken a backseat for the moment.

Discussion

Long bond yields and market-based inflation expectations are rising. Ten-year treasuries rose to 1.10% while the five-year, five-year-forward rate climbed to pre-pandemic levels and then some.

My sense is that the growing upside risk to the economy is driving these moves. With Democrats taking control of Congress and the White House, the path to more fiscal stimulus becomes clearer. From Bloomberg:

President-elect Joe Biden on Friday called for trillions of dollars in immediate further fiscal support, including increased direct payments, after a surge in coronavirus cases caused U.S. payrolls to drop for the first time since April.

“The price tag will be high,” Biden said of his planned package in Wilmington, Delaware. He promised to lay out his proposals next Thursday, before taking office on Jan. 20. “It will be in the trillions of dollars.”

The Fed will be hesitant to get in front of this rate move as long as they suspect it about growth prospects rather than a misunderstanding of the Fed’s reaction function. The fairly limited moves in the short-end of the yield curve suggest the bond market is being driven by the former not the latter. Note too that the space here is a little tricky to navigate. Even if traders start to contemplate a 2022 rate hike, it does not necessarily follow that they are challenging the Fed’s reaction function. It could simply be that market participants are betting that the Fed’s forecast is a notch or two too pessimistic. Fed officials will signal if they think market participants are moving in a direction substantially different from the Fed. With this in mind, note that Clarida this week again expressed a lack of concern about the rising yields.

Lastly, be wary of claims that rising long rates will dampen the recovery. As always, to answer the question of the impact of rates we must first understand what’s moving rates. We should not be terribly concerned if rates are moving higher due to a more promising growth outlook; if that growth does not materialize, then rates will retreat. In other words, this isn’t a taper tantrum situation yet.

Bottom Line

Fed betting on steady policy but with constant reminders that actual outcomes are data driven.

Good luck and stay safe this week!