The big story today will be the ADP forecast of the private sector component of the jobs report, and jobless claims will be of more interest than usual. May delivered a disappointing 138,000 new jobs. If we get another low number, it will be a dollar-negative—whereas in Europe, the shortage of skilled workers is perceived as a positive.
The Fed minutes were a dud. Today Fed funds futures show the probability of a hike in Sept at 18.4% but for December, 50.3%. Of equal interest is that the yield on the 10-year closed at 2.334%, lower than on Monday (2.352%), indicating the bond boys are not pricing in any scary tightening.
The Fed is up a creek without a paddle. Growth is falling. Inflation is soft. Unemployment is ultra-low. And asset prices continue to rise. How can the Fed be confident about normalization when economic factors are behaving abnormally? For one thing, nobody really knows how contraction will affect rates; the WSJ reports the median forecast is for another four hikes in 2018. Really?
The Fed will get another two inflation reports ahead of the September policy meeting. The next Fed policy meeting is July 25-26. Before then, Yellen testifies to Congress next week (Wednesday and Thursday). If bond yields are floppy, she will have a hard time justifying both the pending rate hike and the balance sheet contraction. Not that Yellen has to justify anything to Congress, but the market needs a coherent story. Unless payrolls is a giant number tomorrow, Yellen may not have an understandable story to tell.
One point emerges from the minutes—the Feds are now starting to get concerned about asset inflation, aka a stock market bubble. Vice-Chair Fischer, among others, had already raised the point. San Francisco Fed Williams was the most blunt, naming signs of “some, maybe, excess risk-taking in the financial system with very low rates.” Would the Fed raise rates even in the absence of inflation solely to rein in the stock market? We have seen this question many, many time before. The Greenspan answer is that nobody can spot a bubble until after it has burst. We thought it was a silly response at the time and still do. Cheap money fuels speculation, period.
There is one tiny opening in this sea of gloom—it assumes normal behaviors. But the Trump promises of exuberant 4% growth from tax reform and other measures are not entirely dead. As we showed yesterday, GDP expectations are falling at both the Atlanta and NY Fed. That’s given the conditions we have now. True change in tax policy and infrastructure spending could, conceivably, still turn the ship around.
The problem is that the ship is never going to go at a 4% rate. We might do better than the 1.9% now expected, say 2.5%. That’s the Macroeconomic Advisors revised forecast—revised from 3.6% earlier this year. The chief economist says “the rebound is delayed, not dead, especially as businesses restock warehouses and shelves after drawing on inventories in the first half of the year.” [There’s that inventory thing again.] The big question is how this affects inflation—if it does. Higher growth and a skilled labor shortage can take a very long time to generate higher prices and wages. The Fed is not only preemptive, it’s wildly and perhaps inappropriately pre-emptive. We will know the degree of appropriateness only after we get some actual inflation.
Realistically, inflation prospects are not all that good. A combination of demographics and changing social choices is undermining the usual post-crisis boom. The PCE price index was a low 1.4% in May and not even close to the Fed’s 2% since 2012. The FT notes that blaming special onetime factors like cell phone charges doesn’t really cut the mustard. Many more areas show falling prices, too, including “shelter costs” and core consumer items like cars. “Inflation could be stuck at its 20- year average of 1.7 per cent in a year’s time.”
This is a problem. One analyst told the FT, “The minutes hint at the dilemma the Fed could be facing a year from now if progress on inflation stalls. They could be dealing with inflation that is stuck at 1.7 per cent alongside frothy asset values and higher leverage. That would present the Fed with a very difficult trade-off between its inflation and financial stability goals.”
We don’t have an answer. The Bloomberg headline has it that “Low inflation Frays Fed Consensus.” Are the traditionalists like Yellen right, or the Lowflation Forever camp right? What we do expect is the Fed to err on the side of caution and go with the old Phillips Curve story, the absence of evidence notwithstanding. That means the bond gang will continue to disrespect the Fed and the 10-year yield not make it all that much higher, possibly not past the high of the year at 2.626% from March.
Meanwhile, the ECB is saying conditions are ripe for inflation to rise. The Bund yield kissed 0.50% for the first time since early 2016. The accelerated pace of expectations and yields in Europe should return the euro to most-favored status any minute now. A lousy payrolls number can only whip the sentiment. As usual, we advise Readers to be prudent and get out of Dodge by noon today. Spikes in euro/ dollar on release of payrolls are inevitable. Stop-hunters will be out in force.
Politics: Trump is lazy. He likes to delegate and generally outsource his jobs, hence giving the son-inlaw a gigantic portfolio that includes “peace in the Middle East” and turning over military authority to the generals.
Trump also outsourced the health care bill to Congress, which had already demonstrated it couldn’t make a better bill. If only he had brought his much-advertised deal-making skills to that job, we might have something. We all imagined he would be somewhat like Lyndon Johnson, who bullied and blackmailed Congressionals into doing what he wanted. The presidency is hard work and never-ending work. But Trump prefers to watch TV and bash the press. One wit has come up with “Trumplethinskin."
Trump tried to outsource North Korea to the Chinese, who declined the job. What will he try to outsource to Putin on Friday? Current thinking is that he may not even mention US election hacking, considered a big win for Putin. G20 will almost surely deliver some fireworks. Merkel, for one, has shown contempt for Trump, a rare thing for someone so careful. Everyone fully expects Trump to disgrace himself in some way or another.
By Barbara Rockefeller
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