Monday Morning Notes, 2/22/21
If You Don’t Have Time This Morning
The Fed’s not worried about rising long yields. They would be more worried if markets started pricing in 2022 rate hikes. That would clearly be ahead of the Fed’s policy signaling given current data.
As of Sunday, Bloomberg estimates that the U.S. has delivered 61.3 million doses of vaccine and the rate of vaccination slipped to 1.33 million doses per day.
Recent Data and Events
Highlights of last week’s data included the retail sales report that revealed households bolstered by fiscal stimulus went on a spending spree in January:
That report almost speaks for itself. Housing starts pulled back a notch:
The important number though was building permits, which surged higher to an annual rate of 1.9 million units, the highest level since May 2006 when the market was on the downside of the housing bubble:
Permits are just future starts and the associated economic activity. The housing market is poised to remains a supportive force in this recovery in sharp contrast to the last recovery.
Industrial production also surprised on the upside in January and stands just 1.8% below last year’s level:
The IHS Markit preliminary index for February revealed a slight moderation in manufacturing activity although it remains at an overall high level. The services sector though edged higher to a 71-month high and pulled the composite number up also to a 71-month high. Price measures reached record highs for the series. For the Fed, the important question is how much those pressures are passed through to consumer prices and if they represent one-time price adjustments as the economy recovers.
Initial unemployment claims edged higher unexpectedly. The number though appears to have been pushed artificially higher by a surge of fraudulent claims in Ohio.
Upcoming Data and Events
A fairly active data week with a number of key reports I am watching. Wednesday, we get new home sales for January. As I noted earlier, this has been a bright spot for the economy and should continue to be so. Thursday, we get the latest on another bright spot, durable goods orders, which have defied expectations with a v-shaped recovery from last spring’s plunge. Also on Thursday is the usual initial jobless claims report. The personal income and outlays report for January arrives at the end of the week. Given fiscal stimulus and the retail sales data, markets are expecting the year began with a bang for consumers with strong gains anticipated in both income and spending. Keep an eye on the saving rate and wages and salaries. I expect both will suggest considerable spending power continues to build. Finally, we get February reports on consumer confidence (Tuesday) and sentiment (Friday)
Fed speakers will be out in droves this week. Expect to hear commentary from Regional Presidents Kaplan (Dallas), Bostic (Atlanta), Bullard (St. Louis), and Williams (New York). More important will be Federal Reserve Governor Michelle Bowman speaking Monday on economic inclusion, Federal Reserve Governor Lael Brainard speaking Wednesday on the maximum employment mandate, Federal Reserve Vice Chair Richard Clarida speaking Wednesday on the economic outlook, and Federal Reserve Vice Chair for Supervision Randal Quarles speaking Thursday on stress tests.
Last but of course not least, Federal Reserve Chair Jerome Powell will be delivering the semi-annual monetary policy report to Congress in hearings at the Senate Banking Committee (Tuesday) and House Financial Services Committee (Wednesday).
|Tuesday||Confer. Board Consumer Confidence, Feb.||90.0||89.3|
|Wednesday||New Home Sales, Jan.||855k||842k|
|Thursday||Durable Goods Orders, Jan. prelim, m-o-m||1.1%||0.5%|
|Thursday||Initial Jobless Claims||840k||861k|
|Friday||Personal Income, Jan., m-o-m||9.5%||0.6%|
|Friday||Personal Spending, Jan., m-o-m||2.4%||-0.2%|
|Friday||PCE Core Deflator, Jan., m-o-m||0.1%||0.3%|
|Friday||Univ. of Mich. Consumer Sentiment, Feb.||76.4||76.2|
Fed Speak and Discussion
In an interview last week, New York Federal Reserve President John Williams provided commentary that serves as good guidance of how the Fed interprets recent market activity. First, he downplays concerns about asset valuations that were renewed when the minutes of the January FOMC meeting revealed the Fed staff described financial vulnerabilities as “notable.” Williams though still has a positive interpretation of asset valuations:
“I think the fundamental drivers are optimism among investors that the U.S. economy and the global economy is going to have a stronger recovery and expansion, an expectation of low rates well into the future.”
Williams added that while high asset valuations by themselves were not a problem now they would be if that “gets out of control or you see really strong imbalances resulting from that” but he does not see such conditions as this time. We have seen similar dismissals of high asset prices in recent weeks from other Fed officials. In short, the Fed does not at this point view high asset prices as reason to reduce monetary accommodation when employment and inflation remain far from the Fed’s objectives. Financial vulnerabilities may play a bigger role in monetary policy at some point after the Fed is closer to its objectives, but that will be sometime down the road.
Second, Williams is unflustered by the rising long rates. Here again he echoes his colleagues. This has been a hot topic in recent days although rates have yet to follow equity prices and return to pre-pandemic levels:
Williams attributes the rise in yield over the “past several months” to extra fiscal support and progress on vaccinations that should accelerate the recovery, rising inflation expectations, and higher real rates in the future. In other words, basic theory of the term structure of rates tells him that the rise in yields is not a concern and simply reflects a better economic outlook.
The interviewer follows with a question prodding Williams to ponder when the Fed would consider rising yields something the Fed needs to address. Williams dodges the question by explaining he is not focused on a particular level of longer-term interest rates or asset prices when setting policy. I don’t really think that explanation fully reflects his thought process. A macro theorist might think it was a poorly framed question.
The basis for that question is the assumption that rising rates must be a “bad” thing that “harms” the economy. This is a common misperception that leads some commentators to conclude that the Fed necessarily must step on the longer end of the yield curve. The problem with this line of thinking is that you can’t really discuss the implication of higher rates without first understanding why rates are rising. Williams provided the proper framework for thinking about rising rates as the result of an improving economic outlook. He is describing an economy that is characterized by a new constellation of prices in which asset prices and interest rates can both move higher.
The Fed would be concerned if a misperception of the expected path of monetary policy drove rates higher as in the infamous 2013 taper tantrum. That’s not what it happening here. To look for that, the Fed will be watching the short end of the yield curve particularly out to two years, which at the moment is still locked down pretty tightly:
That’s the zone in particular the Fed would be worried about given that they don’t see sustainable inflation at or above 2% as likely this year or next. Recall that in 2013, the taper tantrum entailed a roughly 30bp increase in 2-year rates between May and September:
Whole different story now. To be sure, market participants are increasingly pricing in rate hikes for 2023, but so too are some FOMC participants. As of the December 2023 SEP, five participants expected to lift off from the zero-lower bound in 2023 and we should not be surprised that more eventually follow later this year given prospects for controlling the pandemic.
Third, Williams does not fear fiscal stimulus:
“…I’m not really concerned about fiscal support right now being excessive or anything like that. Really, what I want to see is an economy that gets back to full strength as soon as possible.”
This again is not just Williams; the Fed is onboard with the Biden administration’s plan to crank up the economy. Recent inflation history tells the Fed that it can’t justify pre-emptively offsetting fiscal stimulus with tighter monetary policy. In contrast, former U.S. Treasury Secretary Larry Summers doubled-down on his argument that planned fiscal policy was excessive and that he believed Fed rate hikes would be “well underway” by the end of next year. He says the Fed “does not recognize the challenges of the era they are heading into,” which he says will be challenges like the 1970s.
The fiscal policy train is leaving the station. The Fed does not intend to preemptively derail that train. Could Summers be correct, and the Fed need to shift course in 2022, much earlier than expected? Sure, it is possible. The Fed’s actual policy path will be outcome-based. It will be watching for evidence of sustainably higher inflation emerging during the second half of this year that can’t be explained away as base effects or one-time price changes. If that occurs, the Fed will be put in a position of adjusting the expected policy path. They know that is a possibility but see it as remote; I don’t think the Fed is as unprepared for the challenge as Summers suggests. It would not surprise me if the immediate impact of Summers’ remarks is that Republicans seize upon them to challenge Federal Reserve Chair Jerome Powell to defend both the Biden administration’s fiscal plans and the Fed’s expected policy path at this week’s semi-annual monetary policy report testimony.
The Fed remains unconcerned by rising long yields. In a sense, such increases driven by an improving economic outlook are welcome. The Fed would be more concerned if market pricing for a rate hike moved into 2022. Policy makers would have a hard time seeing that as consistent with their signaling and the current data flow. Remember, while they are very much paying attention to the totality of the data, policy makers are primarily looking at employment and inflation moving substantially closer to their objectives before they strongly signal a more imminent change in policy.
Good luck and stay safe this week!