Tuesday Morning Notes, 2/16/21
If You Don’t Have Time This Morning
The Fed intends to let the economy run red hot and the inflation data has yet given them a reason not to do so.
As of Monday, Bloomberg estimates that the U.S. has delivered 54.6 million doses of vaccine and the rate of vaccination now exceeds 1.6 million per day
Recent Data and Events
Last week was fairly light for major data releases. The highlight was the consumer price index for January. Headline and core inflation were both up 1.4% compared to a year ago. Core was reported as flat compared to December but was up a scant 0.4% on an annualized basis:
Shelter inflation, which is a third of the index (although a smaller portion of the PCE price index) has slowed to a crawl:
The slide in shelter inflation is helping hold down the overall price pressures which in turn ensures the Fed holds rates near zero for the foreseeable future. To be sure, shelter inflation is calculated on the basis of rent and owner’s equivalent rent and not on the price of housing itself. The objective is to capture the service value of housing rather than the investment value. Of course, it is not lost on anyone that home price appreciation has accelerated in recent months:
The Fed’s focus on consumer prices rather than asset prices means that home prices currently fall into the category of stock prices, interesting but not a determining factor of monetary policy unless those assets create financial stability concerns that could not be mitigated with regulatory action.
The JOLTs data for December revealed that the underlying jobs market remained resilient despite the winter wave of the pandemic. Please see the 2/10/21 Fed Watch for more details. Preliminary Michigan consumer sentiment for February disappointed at 76.2, down from 79.0 the prior month. The measure has been largely bouncing around sideways since September.
Multiple media outlets report that Michigan State University economist Lisa Cook and AFL-CIO chief economist William Spriggs are being considered for the Federal Reserve Board of Governors. One spot on the Board is currently available.
Upcoming Data and Events
A busier week ahead. Wednesday brings three significant releases with the producer price index, industrial production, and retail sales reports for January. The last will garner the most attention as market participants look to retail sales see how much the December fiscal support offset the winter wave of the pandemic. Expectations are for a 1% gain in the control group compared to a sharp 1.9% drop in December. A solid gain would help support the growing optimism for later this year. Also Wednesday the Fed will release the minutes from the January FOMC meeting. The minutes are expected to reinforce the dovish message delivered by Federal Reserve Chair Jerome Powell in the post-FOMC press conference.
On Thursday we get building permits and housing starts. The housing market has been a bright spot during the past year and is expected to remain healthy as the Millennial generation ages into its homebuying years. Keep an eye on that bulge of people in their late 20’s as they will be increasingly driving patterns of activity as they age:
On Thursday comes the usual initial claims report. To round on the week Friday, Markit releases preliminary manufacturing and services PMIs for February and we also get data on existing home sales for January.
Fed speakers this week include Richmond President Thomas Barkin (Wednesday and Friday), Boston President Eric Rosengren (also Wednesday and Friday), Atlanta President Raphael Bostic (Thursday), and Governor Lael Brainard (Thursday). Brainard will be speaking on climate change at the Institute of International Finance’s U.S. Climate Summit.
|Wednesday||Core PPI, Jan., m-o-m||0.2%||0.1%|
|Wednesday||Retail Sales, Jan., m-o-m||1.0%||-0.7%|
|Wednesday||Retail Sales Control Group, Jan., m-o-m||1.0%||-1.9%|
|Wednesday||Industrial Production, Jan., m-o-m||0.4%||1.6%|
|Thursday||Housing Starts, Jan.||1659k||1669k|
|Thursday||Initial Jobless Claims||765k||793k|
|Friday||Markit U.S. Manufacturing, Feb. preliminary||58.5||59.2|
|Friday||Markit U.S. Services, Feb. preliminary||57.9||58.3|
|Friday||Existing Home Sales, Jan.||6.62m||6.76m|
Fed Speak and Discussion
San Francisco Federal Reserve President made extensive comments in a Wall Street Journal interview. Questioned about tapering, Daly said:
So, as you read in our December statement, we’re looking for substantial further progress on our goals. And so I can’t talk about what the committee will do, because we have to decide as a committee what we will do as the economy evolves. But just put it through the lens of my modal outlook. So if you take the lens of my modal outlook, then it’s really continuing to purchase at the current pace through the end of this year, and then should the economy deliver the robust growth in the second half of the year that we’ve—that I’ve projected, and continue to be on firm footing going forward, then I can see the need to keep the current pace as not being as critical. But for 2021, keeping the current pace throughout this year, and thinking about as the economy evolves, reducing the pace of purchases in 2022.
I was surprised that Daly gave a date to tapering after the Fed just went through the process of shutting down the tapering talk. It confirms my suspicions that Fed presidents are going to have a hard time not talking about tapering. Importantly, Daly describes her modal outlook as 5% to 6% for 2021 on the back of a strong second half to the year as the pandemic comes under control. Regardless of the Fed’s general reticence to place a date on tapering, I think that the realization of an outlook she describes will lean the Fed towards tapering in 2022. Like everything else though, it is pandemic dependent.
Federal Reserve Chair Jerome Powell’s speech strongly reiterated the theme that a strong labor market will yield widespread benefits throughout the economy and the U.S. is currently a long way from returning to such a market. When assessing the pre-pandemic state of the economy, Powell said this:
These late-breaking improvements in the labor market did not result in unwanted upward pressures on inflation, as might have been expected; in fact, inflation did not even rise to 2 percent on a sustained basis. There was every reason to expect that the labor market could have strengthened even further without causing a worrisome increase in inflation were it not for the onset of the pandemic.
The Fed is clearly not concerned about overheating the economy. This is particularly relevant given the recent debate on the potential for overheating from President Biden’s $1.9 trillion fiscal stimulus plan. Powell is giving no indication that he sees a substantial risk of overheating if he is thinking we can push the labor market harder than in 2019. Powell is not going to attempt to offset fiscal stimulus before he has inflation data to justify such a policy shift.
The Fed under Powell clearly intends to fully support the Biden administration’s effort to supercharge the economy. This doesn’t mean that the Fed will sit on the long end of the curve, but it does mean that the Fed does not intend to pull monetary support too early in the cycle. In practice then if you are betting on the Fed to hike rates before 2024, you are betting on a particular inflation outcome. If inflation remains persistently stuck near or below 2%, the Fed will let the economy run hot for a protracted period of time. Note that the potential nominations of Cook and Spriggs to the Board would be insurance against the Fed turning unexpectedly hawkish. I don’t think either would risk backward progress in the labor market in an effort to fight an inflation phantom.
The Fed is joining with the Biden administration to supercharge the economy.
Good luck and stay safe this week!