The Beckner Quick Take
The Quick Take from Steven Beckner on all things related to the Federal Reserve and monetary policy. Shorter, punchy, time sensitive reporting from the veteran financial journalist.
InTouch Capital Markets clients receive this content before we publish it on the website – to trial our services, please click for a Free Trial
Rising Wages To Cheer The Fed, Boost Rate Hike Odds
2nd February 2018
Sluggish wage growth has been perhaps the biggest bugbear for the Federal Reserve, slowing the pace of interest rate normalization over the past two years. But that sense of dread could dissipate as wage pressures mount in tightening labor markets, as the Fed had long predicted.
Wages are still rising more slowly than in past expansions, due to weak productivity, but the trends are in an unmistakably favorable direction, as shown by the January employment report. Together with a bigger than expected rise in non-farm payrolls, the Labor Department reported average hourly earnings rose 0.3% last month on top of an upwardly revised 0.4% December gain. That leaves average hourly earnings up 2.9% from a year ago — fastest pace since the recession — after averaging 2.5% the last year or so.
Average hourly earnings are not regarded as the best measure of wages by some Fed economists, but the uptick is consistent with other recent data, which show a pattern of slow but steady improvement. Labor compensation (from the productivity report) picked up in the fourth quarter to 2.4% versus 1.8% in the third quarter, with higher rates for durable goods manufacturing workers. The December personal income and spending report showed wages and salaries rising 0.5%, up from 0.4% in November. Similarly, the employment cost index picked up in the fourth quarter, rising at an annual rate of 2.6%, up from 2.5% in the third quarter. Anecdotally, the Fed is getting increasingly widespread reports of skilled labor shortages, which are forcing employers to bid up wages.
If it continues, this trend should calm dissident fears about below-target inflation and reinforce inclinations to firm monetary policy. Other things being equal, faster wage gains increases the odds of a fourth rate hike this year.
Beige Book Hints More Signs Inflation Picking Up
17th January 2018
The Federal Reserve’s survey of economic conditions in its 12 districts through Jan. 8 suggests a further progression toward rising inflation pressures — lending anecdotal support to statistical evidence on faster wage-price increases.
Nothing dramatic, mind you. The Nov. 29 beige book said, “price pressures have strengthened since the last report” and that “most Districts reported modest to moderate growth in selling prices and moderate increases in non-labor input costs.” The Jan. 17 beige book, which will be reviewed at the Jan. 30-31 Federal Open Market Committee meeting, simply says, “most Districts reported modest to moderate price growth since the last report…”
But in a significant change, the latest survey, summarized by the Atlanta Federal Reserve Bank, found “firms in some Districts noted an ability to increase selling prices.”
There were also somewhat stronger nuances on wages in the latest beige book. “Most Districts said that wages increased at a modest pace,”
but “a few Districts observed that firms were raising wages in a broader range of industries and positions since the previous report.” And “some Districts reported that firms expect wages to increase in the months ahead.”
By contrast, the November survey found “wage growth was modest or moderate in most Districts,” with wage increases “most notable for professional, technical, and production positions that remain difficult to fill.” The last report said, “many Districts reported that employers were raising wages as well as increasing their use of signing bonuses and other non-wage benefits to retain or attract employees.”
The findings follow faster December increases in consumer prices and average hourly earnings.
Meanwhile, inflation expectations keep creeping up. The New York Fed’s latest survey found “median inflation expectations at the three-year horizon increased from 2.8% in November to 2.9% in December, while at the one-year horizon they rose from 2.6% to 2.8%.”
The five-year/five year forward inflation expectation rate, which measures expected inflation in the second half of the 10-year period, fell from 281 basis points at the beginning of 2014 to 141 last June, but has since climbed to 210 as of Jan. 12, according to the St. Louis Fed.
Fed Must Watch Bank Credit, Adjust Rates As Needed If Demand Grows
17th January 2018
Among the things the Federal Reserve’s policymaking Federal Open Market Committee must watch in a faster growing economy is bank credit. It will have to decide how much to raise interest rates as loan demand increases.
So far, banks seem willing to sit on $2.2 trillion of reserves, on which the Fed pays a rising amount of interest. Bank credit has been restrained. Total loans and leases grew 3.2% last year, down from 6.5% in 2016. Commercial and industrial loan growth slowed to 1.1%. Loan demand was called “steady to moderately stronger” in the Nov. 29 beige book. The Jan. 17 beige book reports, “Loan volumes in many Districts were steady.”
But there are signs of acceleration. In December, the FOMC found commercial real estate loan growth at smaller banks “remained strong overall and even picked up a bit,” minutes say. Residential mortgage and consumer credit was “readily available.” Issuance of asset-backed securities funding consumer loans was “robust” Consumer credit increased an annualized 8.8% in November, up from 6.5% in October and 5.7% in September. Revolving credit zoomed 13.25%. Household debt has hit record highs.
What are the monetary policy implications of more expansive bank credit? Will the economy be flooded with inflationary money flows, when reserves transform into loans, as some fear?
Well, that’s not quite how it works. Since the Fed stopped following a scarce reserve procedure during the financial crisis and ballooned reserves through bond buying, it hasn’t mattered how much reserves banks hold. The Fed essentially regulates credit supply and demand by setting the interest rate on excess reserves and other money market rates.
But this does not mean the Fed can ignore credit aggregates. The supply of reserves doesn’t matter — provided the Fed increases the IOER to meet rising credit demand. If demand rises and the Fed fails to raise rates — or doesn’t raise them enough — it could get inflationary credit expansion.
When a bank makes a loan, it credits the borrower’s deposit account, acquiring an IOU. Its balance sheet expands. When the borrower spends the deposit, it gets transferred to another bank along with an equal amount of reserve balances. As one Fed veteran says, “the total amount of reserves stays the same, and doesn’t ‘flow out into the economy.’ It flows out from one bank to another bank, but it stays in the banking system — only the Fed can reduce total reserve balances.”
“This can play out with successive rounds of lending by banks receiving injections of deposits and reserves,” he continued. “The end result is more loans held by banks, more deposits, and the same amount of reserves. So banks have to be happy with more loans and more deposits but the same amount of reserves.”
However — and this is key –“interest rates would have to adjust to make them happy with that (on a risk-adjusted basis).”
Worrying inflation could intensify because rates don’t rise enough to curb credit may seem far-fetched, but things could change.
At Long Last, the Fed Getting the Increased Inflation It’s Wanted
12th January 2018
Sub-par inflation has helped restrain the Federal Reserve’s interest rate “normalization,” but at long last evidence of faster price and wage increases could strengthen the case for lifting rates, provided the uptrend is sustained. Faster inflation and the resulting increase in bond yields could also calm fears about a potentially recessionary “inverted yield curve” and dampen talk about a revamped monetary policy framework.
Inflation has fallen well short of the Fed’s two percent for five years. In November, the year-over-year rise in the Fed’s preferred price index for personal consumption expenditures (PCE) accelerated from 1.6 percent to 1.8 percent, but the core PCE was up only 1.5 percent. Largely because of below target inflation, the rate-setting Federal Open Market Committee has boosted the federal funds rate only five times since lifting off from the zero lower bound two years ago.
Joining Minneapolis Fed President Neel Kashkari in dissenting against the December hike, Chicago Fed chief Charles Evans was “concerned that persistent factors are holding down inflation, rather than idiosyncratic transitory ones.” This week, new Atlanta Fed President Raphael Bostic, a 2018 FOMC voter, warned, “inflation expectations risk becoming anchored below 2 percent,” making it “increasingly difficult for the Fed to hit our 2 percent target.”
Against that backdrop, the December consumer price index comes as a relief to the Fed. The Labor Department says the CPI rose just 0.1 percent overall, but the core CPI rose 0.3%. That left the headline CPI up 2.1 percent year-over-year. The core CPI is up 1.8 percent from a year ago, but over the past three months it has averaged well above two. Previously the agency had reported an uptick in wage growth.
Even before the CPI release, market anticipation of increased inflation helped pushed the 10-year Treasury note yield above 2.5 percent. It pushed toward 2.6 percent afterward. Signifying increased inflation expectations, the “break-even” spread between yields on conventional and inflation protected securities (TIPs) has been climbing as well. That makes the yield curve less flat and prone to inverting.
It’s too soon to say whether this trend will be sustained and induce the FOMC to raise rates more aggressively, but the news goes in that direction. Even before the CPI report, New York Fed President William Dudley was encouraged, predicting late Thursday inflation “will stabilize” around 2 percent “over the medium term,” because “above-trend growth should tighten the labor market further, pushing up wage inflation and eventually services prices.”
“In fact, we have already seen some increase in inflation in recent months,” Dudley observed, noting that over the three months ending with November, the core PCE rose at a 1.8 percent annual rate, up from 0.4 percent last May. He said “transitory factors” have held down year-over-year inflation rates, but “when these transitory influences drop out of the year-over-year numbers this spring, the inflation rate is likely to move higher.”
Following the report, Philadelphia Fed President Patrick Harker remained “guarded,” but said he “expect(s) inflation in the U.S. to continue to run just under our mark this year, rise a bit above target in 2019, and then come back down to our 2 percent goal the following year.” He said he sees two rate hikes “as the likely appropriate path for 2018,” but said he will “monitor the data as they roll in.”
If better inflation numbers continue, officials are apt to become more inclined to raise rates, and we should hear less talk about abandoning or amending the Fed’s inflation target.
FOMC Opens Door To More Aggressive Tightening As Tax Cuts Loom
13th December 2017
The Federal Open Market Committee’s decision to raise the federal funds rate for the third time this year — the fifth since leaving the zero lower bound two years ago — was no surprise. The increase to a 1.25% to 1.5% range was once in doubt, but with GDP growing at a 3% clip and labor markets tightening, the Federal Reserve’s policymaking body had no trouble fulfilling its start-of-the-year projections for the first time since liftoff, even though two Federal Reserve Bank presidents dissented this time because inflation is still undershooting the 2% target.
Of much greater moment is the number of rate hikes 16 FOMC participants, including non-voters, project for next year and beyond. While not huge, alterations to the “dot plot” were significant, though only in the out years.
In September, officials’ median projection for 2018 was three hikes, taking the funds rate to a 2.0% to 2.25% range — 2.1% at the midpoint. For 2019, they reduced the number of projected moves from three to two, taking the funds rate to 2.7%. They saw the funds rate hitting 2.9% in 2020 — a tenth above the longer run “neutral” rate, which was lowered 20 basis points to 2.8%.
Now, they still foresee three rate hikes taking the funds rate to 2.1% in 2018 and see it rising to 2.7% in 2019, but have raised their projection for 2020 to 3.1% — three tenths above neutral. (The projections will be revised March 21st.)
After 145 basis points of reduction in six years, the neutral rate was left unchanged; from here it seems more likely to climb than fall, assuming above-potential growth continues.
“In the background,” balance sheet reduction proceeds apace and will likely continue — provided there is no “material deterioration in the economic outlook,” as the FOMC says.
Clearly, the prospect of fiscal stimulus accelerating already faster growth affected officials’ calculations, but less so their monetary than their economic projections, at least near-term.
Although the 2018 GDP growth forecast was revised up four-tenths to 2.5%, and the unemployment forecast was lowered two-tenths to 3.9%, the funds rate projection for next year was unchanged, though four officials did see the funds rate needing to go a good bit higher than 2.1% next year. Not until 2020 do FOMC participants see the need for more rate hikes than previously anticipated.
Janet Yellen, chairing her penultimate FOMC meeting, acknowledged in her final press conference that “most” of her colleagues “factored in the prospect of fiscal stimulus along lines being contemplated by Congress into their projections.” And she said they generally concurred that tax cuts would boost the economy though both demand and supply-side effects.
Just as clearly, there is great uncertainty about the outlook. The final shape of tax reform and its actual impact is not known. And economic and financial conditions could be affected by non-fiscal forces. As Yellen repeatedly emphasized, “there is considerable uncertainty about the impact (of tax cuts)” and said “it will have to be monitored over time.”
It might seem surprising that the FOMC did not project higher rates next year, but as Yellen explained, “growth a little stronger and the unemployment rate a little lower might push in the direction of a slighly tighter monetary policy, but counterbalancing that is that inflation has run lower than we expect, and it could take a longer period” of low unemployment to get inflation up to 2%.
As events unfold, domestically and internationally, a reconstituted FOMC under new leadership may find it needs to do more or less than now envisioned. But what will matter most, as we step warily into an unknown New Year, is not personnel (Yellen’s designated successor Jerome Powell has basically vowed to continue Yellen’s gradual normalization) but the evolution of the economy.
Goodfriend Will Provide Much-Needed Monetary Economic Expertise
30th November 2017
President Trump’s nomination of Marvin Goodfriend to the Federal Reserve Board of Governor fills a glaring need. With Fed Governor Jerome Powell, a non-economist, set to succeed Janet Yellen as Fed Chairman in February (assuming he’s confirmed) and with Stanley Fischer having retired as vice chairman, Goodfriend will bring much-needed expertise in monetary economics to the Board and to the Federal Open Market Committee. The Carnegie Mellon University professor has plenty of FOMC experience, having served as director of research at the Richmond Federal Reserve Bank from 1993 to 2005. A free market economist and close associate of the late Allan Meltzer, the 67-year-old Goodfriend is a brilliant thinker on monetary policy. Long before the financial crisis, Goodfriend pioneered thinking about how the Fed could provide stimulus at the zero lower bound. He was a leading proponent of paying interest on reserves to facilitate the use of quantitative easing. Though he’s a member of the Shadow Open Market Committee, Goodfriend has been branded by some as “dovish.” That is mistaken. He could just as easily prove hawkish depending on what the data dictate, and he can be expected to vote independently of what the Trump administration might desire.
Powell Handles Confirmation Hearing Very Well
28th November 2017
Federal Reserve Governor Jerome Powell, President Trump’s nominee to succeed Janet Yellen as Fed Chairman in February, aced his confirmation hearing Tuesday. The 64-year-old former lawyer and investment banker seemed totally at home testifying before the Senate Banking Committee. He handled questions from the Senators with aplomb and good humor, while declining to venture into sensitive areas such as tax reform as he repeatedly referenced the Fed’s statutory “dual mandate” of maximum employment and price stability. When it came to monetary policy, Powell broke no new ground. The down-to-earth non-economist was forthright in strongly signaling a December rate hike, but showed a collegial respect for the views of fellow members of the Federal Open Market Committee ahead of the Dec. 12-13 meeting. He let it be known his practice is “not to talk about individual meetings,” because “that’s why we have the meetings — to go in and listen carefully to each other’s views.” Nevertheless, he added, “The case for raising rates at our next meeting is coming together … I think the conditions are supportive of doing that.” Longer range, Powell vowed interest rates will continue to rise. For older Americans dependent on low-earning fixed income investments, he promised, “help is on the way.” After a worthwhile period of “patience” on normalizing interest rates, he said a “strong” economy means that “the very low settings for interest rates after the crisis are no longer appropriate. That’s why we’re raising rates on a gradual path, and I expect that will continue.” The FOMC may raise rates “more slowly” or “more quickly” depending on inflation. Powell twice easily won confirmation to the Fed Board of Governors, and this time should be no different.
Steven Beckner is a veteran financial journalist with four decades of experience of reporting on the Federal Reserve. Mr Beckner is the author of Back From The Brink: The Greenspan Years (Wiley, 1997) and can also be heard speaking regularly on National Public Radio.