Tim Duy’s Fed Watch, 2/3/21
Cost of Suppressing Dissent
There are multiple themes in the Fed commentary I am tracking. One theme is the suppression of dissent. See this via Craig Torres and Liz McCormick at Bloomberg:
Talking about tapering the asset purchases now risks lifting financing costs right when the Fed is trying to stimulate the economy. But squelching diverse views may result in worse policy later. Economic inflection points are difficult to see, uncertainty is high, and in these moments a mix of opinions is important to good policy making.
Recall that last week Federal Reserve Chair Jerome Powell used the bully pulpit of his press conference to encourage bank presidents to avoid speculating on the timing of tapering or even the timing of the discussion of tapering. He emphasized that it was too early to have that discussion. Is it healthy to quash that discussion? The argument against this discussion is without it now you risk an even more abrupt policy shift later in this year. I am not certain that this should be a concern just yet.
This seems to me a conflict between watching the calendar and watching the data. The Fed’s strategy is outcome-based. The Fed will begin tapering when “substantial further progress has been made toward the Committee’s maximum employment and price stability goals.” The Fed has yet to settle on the definition of progress. The Fed can’t have a debate about tapering until they first have a debate about the meaning of “substantial progress.” When Fed presidents discuss the particular timing of tapering, they are putting the cart before the horse. It’s putting the calendar ahead of the data.
I don’t view Powell as quashing dissent so much as clarifying the order of operations. It is clear now that the Fed is far from its goals. It is so far from its goals that it is pointless to discuss tapering because they aren’t even close enough to substantial progress to define substantial progress. The Fed I think will realize that it can encourage debate rather than suppress dissent by discussing what substantial progress looks like such that market participants can envision the runway to tapering as defined by incoming data.
This in fact should be what we are already doing. It will likely be the case that market participants anticipate that substantial progress has been made before Fed policy makers do the same. That will smooth the volatility that might occur when the Fed begins discussing the actual timing of a policy shift. The more the Fed can inform us on the conditions likely to meet the definition of substantial progress, the more likely they can smooth the volatility. It would be helpful, for instance, for Fed officials to debate the relative weights they place on the unemployment rates versus the employment-to-population ratio when defining substantial progress. This kind of data-based guidance would be less disruptive than the calendar-based guidance offered by some Fed presidents.
“GameStop has gotten a lot of attention. If one group of speculators wants to have a battle of wills with another group of speculators over an individual stock, God bless them,” Kashkari said while answering questions during a virtual town hall event”
“That’s for them to do, and if they make money, fine. And if they lose money, that’s on them,” he said. “I’m not at all thinking about modifying my views on monetary policy because of speculators in these individual stocks.”
In other words, Kashkari doesn’t care about this issue and reiterates the point that stock market speculation isn’t a concern for monetary policy. Just because it’s the thing we are excited about doesn’t mean the Fed is excited about it.
A third theme is fiscal stimulus; it plays into the two themes above. President Biden and his fellow Democrats are setting up to move forward a large stimulus measure over the objections of Republicans who attempted to gain bipartisan support for a reduced package. More stimulus can be expected to accelerate the pace of the recovery, increase the level of savings accumulated by households, or some combination of the two. We should be watching to see if the additional stimulus creates the uncomfortable space where it fuels asset price appreciation over consumer price inflation. I know I keep banging on this drum but it seems relevant when many are questioning why stocks keep threatening to push higher.
Separately, manufacturing reports from ISM and Markit indicate that manufacturing remains a bright spot in the economy. Although the ISM employment index continues to hover at the breakeven mark, the hiring index tends to lag and may be weighed down in this cycle by Covid-related constraints on employment.
Bottom Line: Just because the Fed has stopped talking about the timing of the tapering discussion doesn’t mean we can’t start thinking about anticipating that timing. We should be thinking about it in terms of the data and not waiting for Fed officials to give the green light. Keep the focus on jobs and inflation; the Fed will not be distracted by the recent events in financial markets.