What to Worry About Today: "Pivot."
Last week the important analyst and "bond king" Jeff Gundlach said the Fed had "pivoted" on rate hikes, validating the "Powell put" theme that has been around for several months. "Pivot" means "reverse," that is, withdrawal of the expected two or three hikes this year. Some imagine a cut might be possible, including St. Louis Fed Bullard.
The problem is that's not what Powell has actually said. Powell's key words are "flexible" and "patient," meaning hikes are still on the table, but postponed. Chicago Fed chief Evans said last Wednesday the Fed is likely to push rates up three times "eventually" and "If the downside risks dissipate and the fundamentals continue to be strong, I expect that eventually the fed-funds rate will rise a touch above its neutral rate — say up to a range between 3% and 3.25%."
The Fed sees the neutral rate as 2.75%. The top end of the Fed funds range is 2.50% now. To get to 3.25% would ta cut might be possible, including St. Louis Fed Bullard ke three hikes.
We even got a timetable from Evans. "I think developments in the first half of 2019 will be very important for making this assessment of our future monetary policy actions. Hopefully, the economic data will be more like the strong December employment report and financial market volatility will settle down."
Evans is at the hawkish end of the Fed spectrum. Others are more dovish, including Atlanta Fed Bostic (not a voter) who says the Fed should not push interest rates above the neutral level. That still means one hike. Boston Fed Rosengren wants a time-out: "In my view, the appropriate stance for monetary policy is, for now, to not have a bias on moving policy in either direction until there is greater clarity around economic trends here and abroad." But the markets have overreacted. "If the economy continues to be resilient, one might expect financial markets to reprice if it becomes clear that risks had been overstated." After all, inflation is tame at around 2% and even a rise to 2.5% "would not be a big policy concern."
You can go on and on, cherry-picking sentences and phrases to make whichever case you like. Tomorrow we get a speech from Kansas City Fed George, generally seen as a hawk up to now. According to a Reuters graphic at the time of the Dec hike, the Fed's board consists of two doves, 6 hawks and 10 centrists, including Powell.
The Fed doesn't exactly speak with forked tongue, but it's taking the role of soother-in-chief. We can't recall the Fed ever before responding with hints about policy to stock market volatility, or embracing the idea, explored last week, about recession becoming a self-fulfilling expectation. The Fed routinely disregards bouts of hysteria. What's different this time? We have a two word answer: China and Trump.
El-Erian opines in a Bloomberg op-ed that the market sees no hikes this year and cuts in 2020 and 2021, while the Fed is sticking to some hikes, because of six possibilities: the structural improvements in the US economy (jobs, wages) are undervalued; the Fed is cowed by a demanding market; politics; backward looking data is at odds with forward-looking data; the rest of the world is going to hell in a handbasket, and the world has too much debt. It's a pretty good list.
El-Erian says uncertainty is high, "the main risks to the U.S. economy are less organic than political, external and financial; and the risks of a policy mistake and/or market accident are increasing." Deduction: go to cash.
From a political point of view, the big question is how are we going to emerge from Trumpian stances (we don't call them "policies" because that would imply a plan). That includes China trade talks and funding the Wall, with a giant court case around the next corner. TV pundits say Trump usurping the power of the purse from Congress is sufficient cause for impeachment, and never mind all the other stuff like self-enrichment and colluding with Russians.
From an economic point of view, the big question is whether China can spend its way out of a catastrophic slowdown. The key data is the level of imports, showing a lack of demand by consumers. Apple already told us demand for iphone fell off the cliff, and the auto sales data was awful, too. China is a big ship to turn around. If Trump continues to poke and prod, especially on non-merchandise issues like intellectual property and opening markets, a deal will be postponed. Talks are supposed to resume later this month. Don't hold your breath. As we wrote last week, keeping outrage alive against China is a central Trump political need. He is not going to seek a real deal.
Still on the back burner is the slowdown in Europe. In addition to the drop in industrial output, the FT reports a drop in labor productivity "for the first time in a decade, adding to fears about its economic climate. Four of the five largest eurozone economies had negative annual labour productivity growth in the third quarter of 2018 — the first time since 2009 there has been such an across-the-board fall."
One cause is uncertainty that prompts a shutdown in capital investment. Here's the problem: "...persistent slow growth would limit the prospects for higher wages and improvements in living standards. In a region such as the eurozone where population growth is low — and in some countries even falling — it also dents overall growth prospects."
The letters to the FT editors are as interesting as the data... one says the European economy is circling the drain because Europeans do not innovate. "The problem is the mediocrity brought on by Social Democracy which emphasizes re-distribution vs. achievement. No new products ever came out of a Welfare Budget." Okay, deeply political but certainly interesting.
Bottom line, Americans tend to be myopic and see political woes centered on a dysfunctional Congress and even more dysfunctional presidency, but there is trouble elsewhere, too. Uncertainty and fear arise not only from the Oval Office. If global worries take center stage, we could see a respite in the falling dollar. But on the whole, the Fed has the reins and as long as we hear dovish noises, the dollar is on a downtrend. The issue is whether we are hearing what the Feds are saying.
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