According to San Francisco Federal Reserve President John Williams, a number of rate hikes before the end of the year may still prove appropriate. Speaking at an Asian Banking and Finance Symposium in Singapore on U.S. monetary policy, Williams reiterated his view remains that, “Three rate hikes this year makes sense.”
Furthermore, regarding unwinding the balance sheet, the San Francisco Fed president said the process will be “widely telegraphed, gradual, and — frankly — boring…The more public understanding there is, the lesser the risk of market disruption and volatility.”
While we agree with the latter notion of increased communication and preparation minimizing adverse market impact, shrinking a $4.5 trillion balance sheet can hardly be seen as “boring,” particularly given that action taken to reduce principal reinvestment could be seen as a de facto act of tightening and thus, could extend the timeline for future rate hikes.
If anything, at this point, against the backdrop of a still-modest economy and heightened fiscal policy risk, monetary policy action is being regarded with increased excitement and anticipation.
Furthermore, the latest consumer and price data offer little support for a much-accelerated pathway for rates, as Williams would suggest. After slowing in January and February, consumers do appear to be picking up at least a modest amount of steam at the start of the second quarter. But, is it enough to support overly optimistic expectations of 3-4 percent growth? Most likely not.
After all, the modest “gains” are relative to an extremely weak performance early on in 2017. Thus, while an improvement from a noticeably tepid level early on in the year is a welcome step in the right direction, it is hardly an indication of “strong” or “solid” conditions which would warrant a more aggressive Fed.
Additionally, aside from mediocrity in consumer activity, a further reduction in price pressures reduces the need for near-term central bank action, particularly given the fact that many Federal Open Market Committee (FOMC) members have specifically cited rising inflation as the primary reason to move ahead with additional rate increases sooner rather than later.
A four-month low in the Fed’s preferred measure of inflation — personal consumption expenditures (PCE) — alleviates the need for swift action and instead bolsters the argument of the dovish members on the committee, who urge patience and an extended timeline for a higher federal funds rate.
Contrary to John Williams, other Federal Reserve members appear well aware of the uneven and fragile footing that the U.S. economy is still facing and the potential downside risks to output stemming from an uncertain fiscal policy environment.
As St. Louis Fed President James Bullard noted in a speech at Keio University in Tokyo on the U.S. economy and monetary policy, the market’s reaction and rise in investor confidence as of late has been “a honeymoon period” sustained by the “prospects of corporate and personal tax cuts” which have driven stocks higher. The “honeymoon period,” however, he warned, will end if President Trump doesn’t deliver.
We couldn’t agree more, and have for some time continued to support the notion that the recent run-up in market expectations has been based on unfounded optimism of a pro-growth agenda that has yet to be realized. At this point, the market is clearly not focused on the still-modest fundamentals which are arguably little changed from where we were back in the third quarter of 2016, prior to the presidential election.
After all, at the close of 3Q 2016, the Dow was at 18,308, 15-percent lower than present, and the 10-year Treasury bond yield was trading at 1.60 percent, 62 basis points lower than today’s market as of early Wednesday morning. Yet, back then, growth was at 3.5 percent with consumption up 3.0 percent, compared to a current, more lackluster pace of 1.2 percent GDP and a muted pace of consumer spending (0.6 percent) across the first three months of the year.
The Fed is clearly at an inflection point with a growing impatience to raise rates, particularly as market trends suggest an expectation of improved economic conditions to come. But optimism will only go so far or last so long without support from realized gains in growth and inflation.
At this point, still-soft inflation and a moderate consumer resulting in subpar topline growth leaves the Fed to grapple with a desire to follow a pathway to higher rates —with multiple hikes in the remaining eight months of the year — versus acknowledging the modest economic reality and bracing for potential further weakness going forward.
Lindsey Piegza, Ph.D., is the chief economist for Stifel Fixed Income. She has had her research published in Harvard Business Review and in textbooks for Northwestern University’s Kellogg Graduate School of Management. She’s a regular guest on CNBC, Bloomberg, Fox News and CNN.
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