Economic Commentaries

04

To say that relations between the Federal Reserve and the administration are strained is an understatement. This is despite the fact that the Chairman and several Board governors are administration appointees. We are certain there was never any quid pro quo in these selections. We are sympathetic to the administration's criticism, but we are opposed to displays of animosity.

Monetary policy actions have played a role in financial market turbulence and the beginnings of noticeable economic weaknesses. But equally if not more important are simmering trade tensions and a heightened sense of chaos within the White House. We will not comment on the last item but the other two deserve some scrutiny. From our vantage point economic growth peaked in the first quarter of 2018 as the housing market began to reel from rising interest rates and a misguided tax overhaul. Additionally global trade flows began to contract as fear of supply chain disruption surfaced; tariffs were openly discussed and threatened; and a fundamental sclerosis became visible across Europe. On again off again Brexit headlines have not helped.

Since the spring we have warned that the Fed's two pronged strategy of raising interest rates and contracting the balance sheet would be too much for a still fragile U.S. and global economy to absorb. From its verbiage it seemed obvious the Fed never bought into the idea that tax cuts and deregulation could foster a step up in growth without inflation. But a step up in growth is necessary if a soon to be uncontrollable federal budget deficit is ever to be reined in. Meanwhile, inflation has yet to assert itself and if economic conditions continue deteriorating, inflation pressures will remain dormant.

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Posted in: General
02

Fed Chair Powell offered his view of monetary policy at last week's annual Jackson Hole Wyo. conference. He attempted to thread a proverbial needle, arguing against those believing Fed policy risks being too aggressive, while fending off criticism from those believing the Fed is being too tardy, risking a financial bubble and inflation.

With the Chairman highlighting that the Fed's goals of economic growth and price stability are being met, he suggested the best course is for policy to continue toward reaching rate neutrality, without quantifying what may be the neutral rate. The first reaction from financial markets was positive as equities rose, the dollar eased, and bond rates held steady.

Our view is that the Fed is risking being too aggressive if it continues on its present course. The Fed Chairman suggested that evidence in either direction would cause the FOMC to quickly adapt. We think the next few quarters will provide evidence supporting our view. As a precedent we hark back to the mid 1990s. At that time Fed Chairman Greenspan backed away from a diet of raising rates as he detected a surge of productivity flowing from newly emerging technologies. He was right and the economy dazzled.

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Posted in: General
10

In recent Commentaries we pointed to trending weakness in economic data reports as denting global growth prospects and turning attention back toward a U.S. centric one. A strengthening dollar exchange rate, on again off again trade issues, and weak European data reports were all in play over the past few weeks.

Meanwhile, domestic economic indicators point toward a resumption of economic momentum. ISM activity reports for May recouped lost ground from recent months while remaining below levels of late last year. The important orders/inventory mix widened to double digits for the first time this year. And the labor market posted a solid gain for May across almost all industry groups.

For us the implication is that QII GDP is on track for roughly 3.5% growth in the spring quarter with little inflation pressure. Commodity prices have come off the boil. Slow growth in aggregate hours suggests a solid productivity performance while wage growth continues in a 2.5% to 3% range. And importantly since it is key to forming inflation expectations, oil prices have eased since the administration's announced abandonment of the Iran nuclear agreement.

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Posted in: General
30

Trade wars are not fun and they are not easy to win. In fact there are no winners from a trade war as supply chain disruptions and lower trade volumes harm global growth. Global equity market volatility in recent weeks sent this message and we hope policymakers heed this warning.

The economic outlook is cloudier because of this risk and other external uncertainties like NAFTA negotiations and the Iranian nuclear determination. Will households as a result feel inclined to rebuild precautionary balances following a year in which rising confidence and equity values induced a drawdown? They did in the first quarter. How will business decisions be affected? Recently passed tax legislation was supposed to trigger a capital spending boom which would enhance productivity growth and move economies to a higher growth plane. Businesses may now defer investment plans pending clarity on policy and upcoming earnings calls may offer a clue.

And then there is monetary policy. Trade friction is inflationary in the short run and deflationary in the long run. Chair Powell's first FOMC statement mentioned this risk while not offering a policy response. In the short term other concerns have a risen. The first quarter's economic data here and abroad were for the most part weaker than expected. This is possibly a boomerang from storm related consumer strength late last year. And in recent years the first calendar quarter has been weak only to be followed by strength in succeeding quarters. There was also a late tax refund season this year and unusually stormy weather. Consensus forecasts are for a repeat of past years' performance.

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Posted in: General
07

Economic activity was strong heading into the New Year. Households spent freely during the holiday season; payroll growth was solid across industries; and activity indexes here and abroad were strong and better than in November. Real GDP growth in the U.S. may well have notched another 3% annual reading in the October - December quarter with strong momentum going forward.

Expectations are high that tax stimulus will add to this momentum. Households should see a reduction in withholding by late January. Some of this will be spent but with heating bills soaring in much of the country and the saving rate about half last year's level, consumption will be most influenced by job and wage trends. On this score prospects are favorable as the minimum wage is up in many states; a handful of companies have announces bonuses tied to tax reform; and the job market is solid.

But the economy's real impetus should derive from business tax reduction. Corporate rate cuts, repatriated corporate cash, and full expensing for business equipment are presumed to set off a proverbial investment boom. This would be a further spur to productivity and it would generate strong wage and salary income. This is the hope and we shall be closely monitoring incoming data which should soon reflect this.

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Posted in: General
13

Beginning January 21, 2017 there shall no longer be gnashing of teeth over political gridlock. With republicans gaining control of the legislature and the presidency, reform legislation should be crafted and enacted into law fairly smoothly and quickly ( within six months). There will no linger be any excuse for inaction. In our view policy prescriptions for addressing weak and uneven economic growth should be a top priority. This will involve tax reform and simplification and a roll-back of overbearing regulation. Trade and immigration reform should be part of an economic agenda but in the short term these could be divisive and distracting.

The new administration will assume office in an era of sclerotic global growth and also a structurally rising public sector deficit. However, if the economy's growth rate could be raised secularly from 2% to 3% and ideally 4%, the country would be on a path to gain control over the deficit and debt. To do so, private sector risk taking needs to be encouraged and the credit creation process needs to be unleashed.

Near term three things will be front and center in our view. Markets and governments worldwide will carefully scrutinize forthcoming appointments to key economic posts such as Treasury, economic advisory positions, and trade representatives. Markets will also watch for any threats to the independence of the Federal Reserve. Assuming any post election market volatility is brief, the election should not be a deterrent to near term action by the FOMC. We do not think a rate rise in December is necessarily warranted, but the FOMC is desirous of moving toward rate normalization. In any event we would expect any rate move to be accompanied by soothing and cautious language about policy in 2017.

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Posted in: General
13

Speakers at the Federal Reserve's annual Jackson Hole Wyo. conference seemed to talk past each other. One group expressed concern that the U.S. and global economy is in the late stage of economic expansion and inflation and growth are still intolerably low and slow. Indeed, soundings from the BOJ and ECB were in the direction of more accommodation. Others focused on unconventional policies in the U.S. in the event of a downturn, including negative interest rates; a boost to the 2% inflation target; a permanent increase in the balance sheet; targeting nominal GDP.

Of these we think negative interest rates and a boost to the inflation target are the least attractive. Targeting nominal GDP is worth consideration. But ideally this should require joint monetary and fiscal action. Unfortunately this is very likely beyond the ability of policymakers to implement in a vacuum, but fiscal expansion with central bank debt monetization is within the scope of policy coordination.

Meanwhile, in her keynote address Fed Chair Yellen rejected these extraordinary actions, suggesting that the Fed still has sufficient conventional tools to combat recession. Indeed she suggested that even these may not be needed anytime soon because the domestic business outlook is improving. In this vein the Fed Chair suggested that steps toward interest rate monetization could be taken in coming months.

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Posted in: General
08

G-20 finance ministers met last week with little fanfare and little accomplishment. The ministerial communiqué alluded to a growing ineffectiveness of monetary policy while tilting toward the need for coordinated fiscal policy. China was the host country and it intimated that it would boost fiscal spending. Otherwise there was no joint action plan. Finally, G-20 denounced competitive devaluation as a means of boosting exports and growth.

For most countries fiscal policy will remain in a straitjacket near term so monetary policy will still be in focus. With deflation accelerating in Europe the central bank is likely to ease further. With anemic growth in the U.S. and the dollar remaining strong the Federal Reserve is likely to ease by deferring an interest rate increase while modifying its timetable for future increases.

In the current quarter U.S. real GDP growth appears to be running at a 1.5%-2% annual rate as consumption and construction benefit from favorable fundamentals and good weather. But inventories and trade will be drags and business investment remains anemic. Some activity may be being stolen from the spring as well so we have little expectation for any acceleration.

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Posted in: General
05

As the old year ended and a new one begins, the economy and financial markets grapple with three basic domestic issues. These are prospects for fiscal policy; the machinations of voter preferences for the next President; and the Federal Reserve's policy prescription as it affects economic growth and interest rates. None of these seem favorable.

On fiscal policy a compromise omnibus spending bill was passed late last year, avoiding any near term government shutdown. But in doing so lawmakers offered a modicum of fiscal stimulus by agreeing to abandon the sequester caps imposed by the 2011 Budget Control Act. So much for fiscal discipline while nothing was accomplished on the important issues of tax and regulatory reform that might actually aid economic growth.

On the political front it hardly seems likely that tax and regulatory issues will be addressed this year. Indeed, on the democratic side if anything candidates are promising more taxes and more regulation. The republican field remains wide open with fringe candidates exhibiting considerable staying power. Republicans might address tax and regulatory reform in a new administration but concerns over governance could be unnerving.

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Posted in: General
24

With so much attention being directed at this coming week's FOMC policy meeting, we think a few underlying considerations should be kept in mind. These reflect themes we have repeatedly enunciated.

The Federal Reserve has made it very clear that it wants to raise short term interest rates and begin some sort of glide path toward a normalized interest rate environment. Proponents of this desire use two basic arguments. One is that the Fed needs to raise rates so that it would have room to ease in the event of an economic downturn. A second is that with uninterrupted economic growth for the past several years and the jobless rate having declined significantly, there is no longer an economic emergency and thus no need for an emergency interest rate.

A move toward policy would have been facilitated long ago if fiscal and regulatory policies had been growth oriented, but unfortunately this has not been the case. Thus, an emergency rate has been necessary. Nonetheless, raising rates now so they can be cut later if necessary is like banging one's head against a wall to see if it hurts.

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Posted in: General
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