Today’s title is a little tongue in cheek, but there is also quite a lot of truth in it. The chair of the US Federal Reserve has had particular influence over foreign interest rates this year via the ‘King Dollar’ period that exacerbated inflationary pressure for other countries. Although some of the other central banks, especially ones in Europe, were rather slow on the up-take and Japan decided to ignore it entirely. Last week he spoke at the Brookings Institute in Washington, DC, and financial-market ears were alert for any hint of policy moves they could figure out. They had to wait until the last paragraph for the key section.
Monetary policy affects the economy and inflation with uncertain lags, and the full effects of our rapid tightening so far are yet to be felt. Thus, it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.
I am pleased to see him make the lags point, which needed reinforcing. The second sentence rather ignores the fact that they accelerated the pace and have been making the largest rises most recently – an issue I will return to. But then we get what Americans would call the money sentence. As the Federal Reserve mouthpiece at the Wall Street Journal puts it:
What to watch: Beyond the pre-FOMC table-setting around the likely step-down to a 50-bps hike in December. (Nick Timiraos)
So, we are also now wondering about the possibility of the rise being only 0.25% this month.
House prices
As someone who has long argued these are one of the main priorities of central bankers it was hard to miss this bit in his speech:
Housing services inflation measures the rise in the price of all rents and the rise in the rental-equivalent cost of owner-occupied housing.
As readers of my work will know, that is a very odd way of measuring owner-occupied housing costs as he is forced to admit:
Housing inflation tends to lag other prices around inflation turning points, however, because of the slow rate at which the stock of rental leases turns over.
Actually it is good to see that beginning to get out into the mainstream. But the crucial bit is below and the emphasis is mine.
Measures of 12-month inflation in new leases rose to nearly 20% during the pandemic, but have been falling sharply since about mid-year .
We then get back to the issue of lags.
Overall housing services inflation has continued to rise as existing leases turn over and jump in price to catch up with the higher level of rents for new leases. This is likely to continue well into next year, but as long as new lease inflation keeps falling, we would expect housing services inflation to begin falling sometime next year.
It is kind of him to confirm my type of analysis.
Indeed, a decline in this inflation underlies most forecasts of declining inflation.
It is a little convoluted, because we all know that what would have been at the back of the mind and maybe the front too would have been this:
Before seasonal adjustment, the US National Index posted a -1.0% month-over-month decrease in
September, while the 10-City and 20-City Composites posted decreases of -1.4% and -1.5%,
respectively.
After seasonal adjustment, the US National Index posted a month-over-month decrease of -0.8%, and the 10-City and 20-City Composites both posted decreases of -1.2%.
In September, all 20 cities reported declines before and after seasonal adjustments. (Case-Shiller)
The overall picture in the UK housing market was summarised in the report as well.
“As has been the case for the past several months, our September 2022 report reflects short-term
declines and medium-term deceleration in housing prices across the US,” says Craig J Lazzara,
Managing Director at S&P DJI… For all three composites, year-over-year gains, while still well above their historical medians, peaked roughly six months ago and have decelerated since then.
The reality is that the impact of the rises in US mortgages have a way to go. This is for two reasons and the first is structural, with the US tending to have fixed-rate mortgages for the long- (15 years) and the very long-term (30 years). So the impact of changes in rates is slow. Also, the way that the Federal Reserve started slowly with its interest-rate rises and then made much larger ones means that such moves have yet to impact. From the lows of just under 5% for the 30-year (Freddie Mac 4th August) we saw a push up to 7.3% in late October and early November, and that is yet to be fully in play. Even now after the ‘pivot’ thoughts it is 6.6%.
Inflation problems
We get an early nod to the issue.
The report must begin by acknowledging the reality that inflation remains far too high. My colleagues and I are acutely aware that high inflation is imposing significant hardship, straining budgets and shrinking what paychecks will buy. This is especially painful for those least able to meet the higher costs of essentials like food, housing and transportation.
The issue of a change of view really matters due to the existence of lags in monetary policy, and if we use those and look back to we were told this:
But that concern is tempered by a number of factors that suggest that these elevated readings are likely to prove temporary.
In fact, the Federal Reserve had undertaken a particularly sophisticated analysis to confirm this.
These include trimmed mean measures and measures excluding durables and computed from just before the pandemic. These measures generally show inflation at or close to our 2 percent longer-run objective.
How did that work out? It was, of course, a disaster for their credibility, although if we come back to last week’s speech we see that they just cannot stop themselves.
For purposes of this discussion, I will focus my comments on core PCE inflation, which omits the food and energy inflation components, which have been lower recently, but are quite volatile.
Why?
But core inflation often gives a more accurate indicator of where overall inflation is headed.
That is an interesting way of saying they have just failed us as he goes on to confirm:
But forecasts have been predicting just such a decline for more than a year, while inflation has moved stubbornly sideways.
Not Federal Reserve members though, especially those who have been successfully trading the stock market. From Fortune in February:
The Federal Reserve formally adopted tough, sweeping restrictions on officials’ investing and trading, aiming to prevent a repeat of the ethics scandal that engulfed the US central bank last year.
Labour market
This bit was interesting as in a way it echoes the skill shortages point I noted in France last week.
Comparing the current labour force with the Congressional Budget Office’s pre-pandemic forecast of labour force growth reveals a current labour force shortfall of roughly 3-1/2 million people. This shortfall reflects both lower-than-expected population growth and a lower labour force participation rate.
Something has changed across many Western labour markets which is one of the reasons I have less confidence in official unemployment rates as a measure.
Comment
Overall I think that this is a welcome development from the Federal Reserve. Whilst their interest rate of just under 4% is still some way from the inflation rate which, even with their torturing of the numbers, is 5%. But they have back loaded the rises due to their inability to look at the real world rather than their models as inflation picked up. So, in a case of bad timing, they have ended up like a doctor who treats the symptoms after ignoring the causes. Thus they are reducing the dangers of an economic crunch next year.
For the rest of the world we see another route to a reduction in inflationary pressure as the US dollar eases with the UK pound at US$1.21 as I type this and the Japanese yen through 137. Plus the easing of bond yields will feed through over time into lower mortgage rates. Interest-rate rises will be lower as well, although some do not seem to have got the memo.
SGH Macro on the ECB: As things stand, our base case outlook is for a 75-basis point hike in December, to bring rates up to 2.25%, a January start to balance sheet reduction, followed by 50 bps on 2 February, with rates ending up some time in 2023 between 3.5% and 4%. (@AdamLinton1)
As a final point, Chair Powell may have been looking at the trend for his own balance sheet.
Federal Reserve’s weekly earnings remittances due to the US Treasury – $10.6bn .
*All time record low, data series started 2002.
Instead of check, a bill is sent as the Fed realizes losses on its nearly $9tr balance sheet. (@joosteninvestor)
Christine McVie
As a big Fleetwood Mac fan, I was especially sad to hear last week’s news. Rest in peace, Christine, and thank you for the music.
Originally published by Notayesmanseconomics.com and reprinted here with permission.
