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A Tightening in Coming - Is it the Fed or the Market?
As we wrote to clients earlier this week, we had the pleasure of traveling to Jackson Hole, WY to speak at the Rocky Mountain Economic Summit. Also giving talks were Fed Presidents Charles Evans, Charles Plosser, and Dennis Lockhart. The bottom line from the Fed speeches was that U.S. monetary policy should (and will) respond to improving data, as we move toward next year.
As we’ve noted previously, during the crisis the Fed had a conceptually easy but technically hard job. In a crisis, the economics literature is consistent in what to do, ie, you ease, and ease a lot. But easing in a crisis is hard, since in a crisis the “plumbing” in the economy is broken. So, Fed members spent lots of time coming up with new tools (ie, new acronyms: TAF, TALF, CPFF, MMMF, QE, etc). Conceptually easy, but technically very difficult.
Today, we have hit an inflection point: now we have to start talking more about Fed tightening. So, today the Fed’s job is technically easy (the Fed has the tools to tighten, ie, reverse repos, interest on excess reserves, etc). The tools exist, have been tested, and the FOMC is actively setting up a plan to determine the mix of tools to be employed. The key question is: when to use those tightening tools? Technically easier, but conceptually very difficult (especially with the historical example of Japan showing what can happen if the central bank tightens too early).
A year ago, FOMC members were driving home the idea that highly accommodative monetary policy was necessary for the foreseeable future. Easy policy is still likely for the balance of 2014 (the Fed really cannot tighten until it is done tapering QE, which the Fed minutes noted was an October event).
Also a year ago, the FOMC seemed happy that the bond market had stabilized at roughly 2.6% on the 10-year Treasury yield, after the “taper tantrum”. At a minimum, it showed that the Fed was having some success communicating that tapering QE was not tightening. We are still around that level on bond yields. But now, the Fed needs to talk about actual tightening, ie, raising short-term interest rates.
On a shooting range, Fed President Evans noted that his “bulls-eye” would be an ideal combination of unemployment and inflation, ie, achieving these 2 Fed mandates. We’re not there yet. But we’re moving in that direction, and could be close to the “bulls-eye” in 2015.
Indeed, the timely economic data suggest the U.S. labor market continues to look better. Initial jobless claims fell to 304,000 last week, pulling the 4 wk.avg. down to 312,000. The JOLTS data continue to support a bounce in the labor market. The next set of employment reports should tell us 1) how much of a bounce-back (especially in GDP) we’re likely to see in 2Q/3Q of 2014, and 2) how much of the 1Q strength in payrolls (if any) was due to temporary factors around the start of the year (eg, jobless benefits expiring).
The Fed wants to move slowly. But the market tends to move quickly (ie, “over-shooting”). If the Fed wants the precision of a rifle, the market may come closer to an automatic weapon. Even after the first Fed rate hike, FOMC members have noted that their moves to tighten policy are likely to be slow. They want to move at a measured pace. But the market may not move at a measured pace – no one wants to be last out the door, especially in places where that door is small.
Strategas Research Partners
Is the Mfg Renaissance Overemphasized?
One the most important monthly economic statistics is US payroll employment. Yet, the headline number is “non-farm” payrolls, ie, we don't even count the farmers anymore.
What happened? We got much more productive at farming. Now, a small number of people produce all the food.
At the same time, we displaced a lot of workers from the farm. Many more people work in the service sector now, and buy their food at supermarkets.
This is inherently productive. We are doing the same thing we had been doing as self-subsistence farmers (ie, eating), plus doing our other jobs. There are 2 types of jobs in the service sector that we have moved people into: 1) productive service jobs (humans have created logistics, statistics, data analysis, operations research, supply chain analysis, software programming, just-in-time inventory, etc to help streamline the production and distribution process).
Then there are 2) less-productive jobs, which we like because they raise our living standard, and we can afford them now that we are not just farming as a society (entertainment, fashion, sports, poetry readings, blow-dry-only hair salons, etc).
We achieved the gains in the service sector – in part – through a massive investment in education over the past several generations. We've improved the literacy rate and the high school graduation rate. We made a major investment in human capital. Libraries and, later, the internet have made much of the world’s information accessible to many more people. Gone are the single-room school houses.
This fact is relevant when considering the current “manufacturing renaissance” that has captured the US imagination. In many ways, today’s manufacturing renaissance looks like a tech reindustrialization. With technology, a small number of people could produce all the things, just like a small number of individuals produce all the food. The entire goods production sector should become more automated (in fact, it may have already been there, if it had not been so cheap to outsource abroad during the past 30 years).
But now, what does the country do with the displaced workers? When production jobs are automated, where will people work? For that matter, when repetitive service sector jobs are automated, where will people work?
In the past, through education, we were able to move workers into newly-created productive service sector jobs. That – combined with the productivity in the goods sector – gave us a higher overall living standard (and an ability to afford the other jobs in the economy). Sectors such as entertainment were a product of wealth (ie, an expression of how we wanted to consume our higher living standard) rather than a factor that generated wealth alone.
We want and need all three: productive jobs in the goods sector, productive jobs in the service sector, and luxury jobs to increase our living standards. The challenge in the service sector currently is that the old model is proving hard to replicate. We have achieved a better level of productivity, and we have achieved a better level of education as a country. But to see economic growth we need to see productivity growth, and that would suggest we need to advance further. We need to move from a high level, to an even higher level. The issue is: college is proving expensive.
Bottom line: we have a model of raising living standards which has worked historically: ie, improve productivity in the goods and services sector through education. But the question is how much further can we push this model? At this stage of the business cycle – with wages starting to accelerate – we need to find the “new, new thing” without too much delay, or company profit margins could suffer. A manufacturing story alone may not do it.