Written exclusively for InTouch Capital Markets
1st November 2018
By Steven K. Beckner
President Trump continues, indefatigably, to turn up the heat on the Federal Reserve, but Fed officials have given no indication his harsh criticism will cause the independent central bank to diverge from its plan to keep gradually raising interest rates.
The Fed’s rate-setting Federal Open Market Committee would be more likely to desist from rate “normalization” due to untoward “readings on financial and international developments,” which are among the factors the FOMC regularly assesses to determine the appropriate federal funds rate.
But, despite recent sharp declines in U.S. stocks values, signs of slowing in the global economy and other concerns, it is premature to presume the FOMC will alter its monetary policy course — not when the U.S. economy, for now at least, is growing well above trend amid tightening labor markets and nascent wage-price pressures.
The FOMC seems highly unlikely to raise the funds rate as soon as at its Nov. 7-8 meeting, but it would probably take a lot for Fed policymakers not to do so at their Dec. 18-19 meeting. They have dropped too many heavy hints to the contrary.
From an historical perspective, Trump’s criticism of the Fed has been nothing short of startling, even for a president given to inventive name-calling. In past administrations, most criticism of the Fed came from Treasury secretaries and other cabinet members. But this president has taken it on himself, and the more he’s been told his rhetoric is counterproductive the more he has intensified it.
Trump called the Fed “crazy” and “far too stringent,” among other things, after the FOMC raised the funds rate on Sept. 26 for the third time this year.
Former Fed Chairman Alan Greenspan, who came in for plenty of criticism during the Reagan-Bush years from former Treasury Secretary Nicholas Brady, advised on Oct. 18 that “the best thing that you can do if you’re in the Fed is put earmuffs on and just don’t listen.” Others have advised Trump to tone it down.
Instead, as he so often does, the “very unhappy” president has doubled down. Six days later, he told the Wall Street Journal the Fed is “the biggest risk” to the economy, because it is raising rates “too quickly.”
Trump kept up the pressure in an Oct. 29 Fox News interview, complaining that while his predecessor was able to operate with “very low interest rates,” the Fed is now “being very tight.”
Nor has Trump spared Fed Chairman Jerome Powell, his own appointee to succeed Janet Yellen. “Every time we do something great, he raises the interest rates. He was supposed to be a low-interest rate guy. It’s turned out that he’s not.”
Trump alleged Powell “almost looks like he’s happy raising interest rates.”
I don’t know who told Trump that Powell was going to be a pliable “low interest rate guy,” and I don’t know what he thinks he’s accomplishing with his Fed bashing. I can only suppose he is trying to build an excuse he can blame if the economy economic expansion weakens, as some predict it will.
I do know neither Powell nor most of his colleagues seem willing to play ball with the White House. They are not (and have never been) inclined to tighten credit aggressively, but they’re not going to just keep rates unchanged to please Trump.
Leading up to the FOMC meeting, Fed officials have remained on message — as expressed by the Committee on Sept. 26: “The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term.”
In his first public comments since being confirmed as Vice Chairman, Trump nominee Richard Clarida echoed the kind of comments Powell has been making.
(W)ith the economy operating as close as it has in a decade to the Federal Reserve’s dual-mandate objectives of price stability and maximum employment, I believe monetary policy at this stage of the economic expansion should be aimed at sustaining growth and maximum employment at levels consistent with keeping inflation at or close to the 2 percent objective,” he said Oct. 25.
“Even after our most recent policy decision to raise the range for the federal funds rate by 1/4 percentage point, monetary policy remains accommodative, and I believe some further gradual adjustment in the policy rate range will likely be appropriate,” Clarida went on.
“As I look ahead, if strong growth and robust employment gains were to continue into 2019 and be accompanied by a material rise in actual and expected inflation, that circumstance would indicate to me that additional policy normalization might well be required beyond what I currently expect,” he added.
A couple days earlier, Atlanta Federal Reserve Bank President Raphael Bostic, who voted for the September rate hike and two prior ones, said “unless the data talk me out of it, I view a continued, gradual removal of policy accommodation as appropriate until we get to a neutral policy rate. I want to be clear here. My assessment is that monetary policy has not yet reached a neutral stance. We are still providing accommodation.”
Believing “we are still a few rate hikes away” from neutral, Bostic suggested at least three more 25 basis point rate hikes are warranted.
Similarly, Dallas Fed President Robert Kaplan said his “base case for 2019 is to gradually and patiently raise the federal funds rate into a range of 2.5 to 2.75 percent or, more likely, into a range of 2.75 to 3 percent.”
More hawkishly inclined Cleveland Fed President Loretta Mester not only sees a need to avoid inflationary overheating, but warns, “we are at a point in the business cycle where increased attention to financial stability risk is warranted because the economy continues to grow above trend and financial conditions remain accommodative, even taking into account the recent increase in long-term interest rates.”
There are exceptions, as always. St. Louis Fed President James Bullard continues to argue “the current level of the policy rate is about right.” Neel Kashkari, an outspoken “dove” ever since he became Minneapolis Fed President in January 2016, contends the FOMC “should seize this opportunity for a pause.”
“A pause on rate increases would allow the FOMC to gain important insights,” he wrote on Oct. 26. “Crucially, it would help determine how much slack remains in the labor market.”
Bedeviling policymakers is uncertainty about the economy’s growth potential and real equilibrium interest rate (r*), which in turn relate to doubts about investment and productivity growth. But those uncertainties don’t mean the FOMC can or should simply go on hold.
Rather, as another Trump appointee, Vice Chairman for Supervision Randall Quarles, says, “this situation reinforces and supports the importance of a clear, steady strategy and a gradual, predictable approach to the removal of accommodation as we continue to monitor the data….”
“Rather than meaning that policy will drift because of this uncertainty, it means that policymakers should chart a course that is stable, gradual, and predictable; communicate it clearly; and then follow that course through the temporarily shifting and sometimes conflicting signs from the economy unless some strong and steady signal requires a firm but moderate correction.”
“Given that the economy has performed fundamentally as I expected at the outset of this year, the right strategy is to maintain the gradual course that I have thought appropriate for some time now….,” said Quarles. “(W)hile I think that there is enough reason to think that the productive capacity of our economy might be increasing so that we should not feel compelled to accelerate our pace, I also think there is enough doubt about current inflation as an infallibly reliable measure of current resource constraints that the continued gradual removal of accommodation is appropriate…..”
Uncertainties notwithstanding, there appears to be a solid consensus for a fourth 2018 rate hike this year and more to follow — unless the outlook changes dramatically.
For now the economy continues to look robust. The Commerce Department estimates the gross domestic grew a real 3.5% in the third quarter — down from 4.2% in the second quarter, but still faster than Fed and private economists think the economy’s can sustain without rising inflation. FOMC participants projected growth will slow to 2.5% next year, but that’s still well above their 1.8% estimate of longer run GDP potential growth.
Job gains have slowed but still averaged 190,000 per month over the last three months — far above the minimum needed to absorb new entrants into the labor force. The 3.7% unemployment rate is the lowest since 1969. With employers scrambling to find increasingly scarce skilled workers, wages and benefits are increasing more rapidly.
Consumer spending, whose 4% annualized growth drove third quarter GDP, continues to look strong.
Meanwhile, on the inflation front, the price index for personal consumption expenditures (PCE), the Fed’s preferred gauge, has moderated in recent months, rising 0.1% overall and 0.2% core in September. But year-over-year, both indices were still up 2.0% in line with the FOMC’s target.
Relatively tame inflation and inflation expectations enable the Fed to temper tightening, but don’t by themselves warrant a “pause,” in the majority view.
Fed officials have long counted on “well-anchored” inflation expectations to help curb price pressures in the face of high resource utilization, but that doesn’t mean they take it for granted that inflation will stay under control despite above-trend growth and tight labor markets.
As Quarles put it, “There are risks in pushing the economy into a place it does not want to go if we limit ourselves to navigating by what might be a faulty indicator. Anchored inflation expectations might mask the inflation signal coming from an overheated economy for a period, but I have no doubt that prices would eventually move up in response to resource constraints. The ultimate price, from the perspective of the dual mandate, would be an un-anchoring of inflation expectations.”
To be sure, there are cautionary economic signs — danger signals some would say.
Business investment has slowed from its torrid second quarter pace. As home affordability has lessened, the housing sector has cooled. Dollar appreciation and slower growth abroad have hurt net exports.
Even consumer spending, some worry, could weaken. Among the “warning signs” cited by Steve Blitz, Chief US Economist for TS Lombard, are “the continued drop in the saving rate; now back to pre-tax cut levels” due to rising food and energy costs. “Another adverse trend,” he says, “is the sharply rising percent of personal income going to pay interest…”
Then too, as Kaplan acknowledges, “GDP growth has been aided by sizable fiscal stimulus, whose impact is likely to fade somewhat in 2019 and further in 2020.”
The manifold economic ramifications of Trump’s vigorous efforts to undo existing “unfair” trade deals pose another downside risk, which Powell and others have cited.
All of these anxieties, not to mention inordinate interest rate fears, have been making investors wary, pushing U.S. stocks into correction territory. From their early October peaks through Oct. 29, the Dow Jones Industrial Average has fallen 10.5%; the Standard & Poor’s 500 11.5%, and the Nasdaq Composite more than 14%.
Panicky outflows into bonds have pushed yields back down to levels that reawaken inversion fears. The 10-year yield, which had risen as high as 3.25% on Oct. 5 had plunged as low as 3.06% on Oct. 26.
These developments are not purely domestic, of course — not that that’s any comfort to the Fed or anyone else.
If, as some hope, stocks regain much of their losses and markets more generally stabilize, monetary policy probably won’t be much affected. If the losses persist or accumulate, it could be a different story.
So far, Fed officials don’t seem greatly swayed by market developments.
“While a deeper and more persistent drop in equity markets could dash confidence and lead to a significant pullback in risk-taking and spending, we are far from this scenario,” Mester said on a day when the Dow rallied over 400 points. “The S&P 500 index remains higher than it was a year ago. Similar to the swings in the market we saw earlier this year, the movements of late do not seem to be signaling that investors are becoming overly pessimistic.”
“While the market volatility poses a risk to the forecast and bears monitoring, it has not led me to change my modal medium-run outlook,” she added.
Clarida also says financial market turmoil would have to be sustained to change the economic and policy outlook for an economy he calls “very, very solid.”
As this was written, stocks were having another spasmodic rally. The FOMC will obviously be monitoring markets, but unless there is prolonged turbulence manifested in weaker economic conditions, it’s doubtful monetary policy will be much diverted by profit-taking and volatility on Wall Street.