Let’s unpack Clarida’s comments while we wait for Powell

Fed Chairman Jay Powell is set to speak today. And all eyes are turned to him given the negative comments about the Fed and Powell personally that US President Trump made in an interview with the Washington Post. But before we get to Powell, let’s talk about the new Fed Vice Chairman that Trump picked, Richard Clarida, because he gave a speech just yesterday on future monetary policy called “Data Dependence and U.S. Monetary Policy“.

Before I get into that, though, let me mention that this is today’s newsletter edition. It’s actually much closer to investor-level analysis. But let me release it to everyone here. I;m mentioning this, because, a while ago, I took the newsletter subscription off Patreon. But shortly, it’s going to return – but not to Patreon – as I am going to start offering the weekday newsletter through my website. I’m not sure when, but it will be very soon.

Let’s get back to Clarida now.

My view

Let me give you my interpretation of where this has been going:

• Up until October, when equity markets fell out of bed after the Treasury 10-year hit 3.25%, it seemed like the Fed was more likely to accelerate hikes than anything else. We printed 4.2% and 3.5% growth in Q2 and Q3 respectively. And Trump is running huge deficits to bolster the economy at the peak of the cycle. The Fed is supposed to offset that. That’s what they do.
• Now, I am as keen to see what Powell says today as the next guy. But, in some sense, it doesn’t really matter. Given the Fed’s policy guidance and their worries about credibility, the Fed’s policy space is somewhat limited here. Trump’s bloviating about Powell’s supposedly being a ‘low interest rate guy’ makes it hard for the Fed to rescind rate guidance without looking like they’re caving to political pressure.
• Even so, The Fed is on track for a December hike, and then three more in 2019.
• Nevertheless, I expect Powell to be mostly upbeat. Clarida sure was yesterday. But, even if he is ‘neutral’, you still have 4 hikes baked in by the end of 2019. And that’s with the unemployment rate well below the Fed’s long-term bogey. You need to see a big backup in economic growth to change that timetable. Would 2% growth in 2019 do it? I don’t think so.
• All of this is supportive of the dollar, especially given that, relatively speaking, the US is doing well.
• But the Fed knows the tax cut stimulus effect will be petering out in 2019. And so, I think the prospect of hike timetable acceleration has diminished. From a forex perspective, until we see a crisis flight to safety, we may be near a high water mark for the USD here. The 4 hikes through 2019 are baked in. And acceleration looks less likely.
• The first big data point is the holiday sales numbers that come out in early January. We will have a big target then for considering the next rate hike in March. And remember, Pedro da Costa has reported some Fed watchers expect the Fed to basically call it a day in March. So, these sales numbers are a big deal regarding where the Fed is headed.

Clarida’s view

Given all of that, take a look at what Richard Clarida said yesterday. Here are a few quotes that I think encapsulate his commentary. And a lot of this is very bullish, one reason I expect Powell to be bullish too, since they would have seen each other’s speeches before they gave them.

• Bullish US economic data: “U.S. economic fundamentals are robust, as indicated by strong growth in gross domestic product (GDP) and a job market that has been surprising on the upside for nearly two years. Smoothing across the first three quarters of this year, real, or inflation-adjusted, GDP growth is averaging an annual rate of 3.3 percent. Private-sector forecasts for the full year–that is, on a fourth-quarter-over-fourth-quarter basis–suggest that growth is likely to equal, or perhaps slightly exceed, 3 percent. If this occurs, GDP growth in 2018 will be the fastest recorded so far during the current expansion, which in July entered its 10th year. If, as I expect, the economic expansion continues in 2019, this will become the longest U.S. expansion in recorded history.”
• Bullish US jobs data: “Likewise, the labor market remains healthy. Average monthly job gains continue to outpace the increase needed to provide jobs for new entrants to the labor force over the longer run, with payrolls rising by 250,000 in October. And, at 3.7 percent, the unemployment rate is the lowest it has been since 1969. In addition, after remaining stubbornly sluggish throughout much of the expansion, nominal wage growth is picking up, with various measures now running in the neighborhood of 3 percent on an annual basis.”
• Caution about inflation accelerating: “The inflation data in the year to date for the price index for personal consumption expenditures (PCE) have been running at or close to our 2 percent objective, including on a core basis‑‑that is, excluding volatile food and energy prices. While my base case is for this pattern to continue, it is important to monitor measures of inflation expectations to confirm that households and businesses expect price stability to be maintained. The median of expected inflation 5-to-10 years in the future from the University of Michigan Surveys of Consumers is within–but I believe at the lower end of–the range consistent with price stability. Likewise, inflation readings from the TIPS (Treasury Inflation-Protected Securities) market indicate to me that financial markets expect consumer price index (CPI) inflation of about 2 percent to be maintained.”

The conclusion: “As the economy has moved to a neighborhood consistent with the Fed’s dual-mandate objectives, risks have become more symmetric and less skewed to the downside”

Clarida says that “supports the case for gradual policy normalization”.

Problems?

I wrote some of this up on Twitter just now and Dartmouth (go Big Green!) Economics Professor Danny Blanchflower responded by calling Clarida out on his models.

basically says nothing – seems these no data folk on the fed can’t cope with the employment rate being 3 percentage points below 2008 levels and underempt elevated which suggests US nowhere near full-empt which is why there is weak wage growth – totally unconvincing speech https://t.co/jWVHr747vJ

— Danny Blanchflower (@D_Blanchflower) November 28, 2018

indeed I read the speech to say our models are great sadly the real world isn’t complying – makes the economics profession look ridiculous once again https://t.co/hc72F7Py35

— Danny Blanchflower (@D_Blanchflower) November 28, 2018

Danny has a point here. Clarida’s speech is basically saying: “Look, the low inflation data don’t fit our models of accelerating inflation below 4.5% unemployment rates. So let’s hike a bit more slowly here lest we crash the economy while we figure out why our models are broken.”

That doesn’t leave me with a high level of confidence. Yet, as I have asked repeatedly, if the Fed doesn’t hike now, then when should they? I mean yesterday I showed you how credit excess had spun out of control and is finally coming down to earth – under the Fed’s rate hike regime. The question seems to be the one Clarida seems to be asking:’it’s not a question of if we should raise rates, but one of how much and at what tempo.

If the Fed gets this horribly wrong, bad things can happen. You could argue that the Fed has already got it horribly wrong, allowing credit excess to spiral out of control, risking an eventual hard landing no matter what they do.

My view: The Trump deficits are too late in the cycle to work. The Fed will offset them. We should have had bigger deficits under Obama because the monetary offset would have prevented some of the excess that built up then. But we didn’t do that. And now, we’ll just have to see how big a mistake that was.