June 14th, 2018

Fixed Income Note Morning Note

June 2018 FOMC Post-Mortem: dealing with a Greenspan-esque economy

Starting seemingly off-topic, Fed Chair Powell is turning into the antithesis of his predecessors Bernanke and Yellen. While Bernanke and Yellen were relatively clear on the Fed’s policy intensions, Powell is decidedly more vague. Notably, Powell doesn’t directly answer questions that journalists fire at him during the press conference. Instead, he dodges them by responding with generalisms that remind us of former Fed Chair Greenspan’s purposeful obfuscations. No surprise here as the economy is becoming more Greenspan-esque – “irrational exuberance” and all that – than Yellen-esque or Bernanke-esque. Financial instability, overheating of the economy, but also over-tightening are bigger risks than lost output or hysteresis.

Yellen and Bernanke in particular were dealing with a vastly different set of economic circumstances: financial instability at home and abroad; and deflationary pressures and persistent economic weakness despite unprecedented monetary policy largesse. Keeping financial conditions under such circumstances easy required blunt language at times.

And come to think of it, Greenspan gravelly voice stands in stark contrasts with Powell’s gentle and rather comforting lawyery tone.

But to answer the over-arching question we had before the meeting: to what extend is the Fed willing to push the federal funds rate into restrictive territory (which will very likely invert the yield curve), Powell’s answer was: it depends. If the appropriate policy is to continue raising the federal funds rate further and into what the Fed sees as restrictive territory (beyond 2.875), and if that flips the yield curve, so be it. The question then turns to: what’s appropriate policy? Powell’s way of doing things is look at the data first and foremost. Roughly speaking, the data has been showing the same picture for quite some time: growth that is clearly above potential; a solid labor market with an ever-decreasing unemployment rate that drifts further below sustainable levels; and benign inflation that is now finally around target. For the foreseeable future the Fed expects things to stay pretty much the same.

In other words, it’s what we’ve been saying since the late autumn of 2017: given the economic outlook and the economic data backdrop, the Fed will have a hard time not raising rates at every quarterly meeting unless something bad happens. While Powell may have professed tonight that he will not make the mistake (of his predecessors) of tightening too slow or too fast, the stage is set for the Fed’s serial murdering of every single post-war economic expansion by over-tightening at some point. After all, if growth doesn’t slow down and the unemployment rate doesn’t stabilize, Powell will find it difficult not to hike.

Still, credit to Powell for refusing to be drawn in on if he will push the federal funds rate into restrictive territory. The Chair’s carefulness on the matter helps explain why the yield curve didn’t meaningfully flatten (at least not in the 2y10y sector) tonight.

Now, on to the more mundane stuff. Starting with the statement, which was drastically overhauled. The forward guidance was cut back to generalized language describing what moves the federal funds rate. As expected the wording that the federal funds rate will stay low relatively to historical levels was cut. The FOMC still describes the policy stance as accommodative though, giving cover for further tightening.

The median dot for 2018 moved up to four from three hikes, despite our bean-counting showing no such change yet. In any case, the median dot at four suggests the core of the FOMC is now officially on board for four hikes this year. Before today there were reasonable doubts that the top brass were split on 3 or 4 hikes.