A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



The Fed Should Boost Rates, But Not Just Yet

The Federal Open Market Committee will keep interest rates unchanged at its meeting the week after next.

I am not an economist, neither do I play one on television or anywhere else. Therefore, I shall deal with this question with a single hand.

And, to repeat, at its highly anticipated meeting on Sept. 16-17, the Federal Reserve’s policy-setting panel will opt not to lift its target range for federal funds from the 0-0.25% range that has prevailed since the darkest days of the financial crisis in December 2008. No ifs, ands or buts.

I write this without any inside knowledge of the thinking of the FOMC or of any inkling of the economic data that will be released in the days leading up to the confab. That includes the key employment report for August that will be released Friday morning just before traders and investors make a hasty exit, appropriately enough, for the long Labor Day weekend.

Another increase in the neighborhood of 200,000 or a bit more in non-farm payrolls, in line with the recent trend, is likely. And the headline jobless rate is apt to continue to hover around the 5.2% mark, with a twitch of a tenth of so possible owing to vagaries of the monthly employment survey.

But, no matter. Notwithstanding its protestations that its decisions depend on the incoming data, the numbers that count are those of the financial markets. And after another drubbing in the Dow Jones Industrial Average Tuesday, plus the renewed retreat in oil prices, there shouldn’t be much further debate.

Of course, there will be, notably between those who come from academe and those who hail from finance. Among the former is Stanley Fischer, the Fed vice chairman, who previously headed Israel’s central bank and prior to that was a professor at the Massachusetts Institute of Technology, where he was the PhD thesis advisor for former Fed head Ben Bernanke, European Central Bank President Mario Draghi and Gregory Mankiw, the former chairman of the Council of Economic Advisors under George W. Bush.

The latter contingent includes New York Fed President William Dudley, a post that makes him vice chair of the FOMC and a permanent voting member of the panel, reflecting New York’s position at the center of the global financial system. Dudley formerly was the chief domestic economist at Goldman Sachs, which surely provided him the perspective of the working of the financial markets (and fodder for critics who contend the New York Fed is too close to the powerful institutions it oversees).

Be that as it may, Dudley’s comments last week that the arguments for a September liftoff in the fed funds rate target was “less compelling” pulled markets for risky assets such as stocks out of a nosedive. But, over the weekend at the Kansas City Fed’s annual junket in Jackson Hole, Wyo., Fischer provided a professorial argument for a rate hike, saying that the central bank shouldn’t wait until inflation met its 2% target since prices already are moving in that direction.

Those arguing for a hike contend that six years into an economic expansion, there is no justification for maintaining an emergency interest rate near zero.

To which it might be responded, what’s the hurry after all this time?

As the especially insightful Raghuram Rajan, the head of India’s central bank, commented at Jackson Hole last weekend: “My position over time has been, don’t do it when the world is in turmoil…It’s a long-anticipated event; it has to happen sometime, everybody knows that, but pick your time.”

That time could just as easily be at the Oct. 27-28 FOMC meeting. While there is no scheduled press conference following the confab, a check of the calendar shows its 2015, when reporters actually could pose questions to Fed Chair Janet Yellen via a remote video hookup. Then there’s the Dec. 15-16 FOMC, which will have a face-to-face presser.

In any case, given the global flight from risk assets and the ongoing deflationary downdraft from commodities, I would wager strongly that the Fed delays its rate liftoff.

That the effects of the fall in crude prices extend beyond the futures pits was evident in the announcement Tuesday of ConocoPhillips’ (ticker: COP ) announcement that it will cut 10% of its jobs, putting some 1800 employees out of work. Previously, Schlumberger ( SLB ) said it was cutting 20,000 staffers. These are well-paying jobs, much more so than the service positions that have dominated the payroll gains.

I would further argue corporate executives who make decisions to hire and spend are influenced by prices of their companies’ stocks (and perhaps those in their personal portfolios as well).

Budgets for 2016 may be finalized after the brass returns from their holidays in the Hamptons, Martha’s Vineyard or whatever posh spots they frequent. A stock swoon may induce them to hold back, even more than a slowing of orders, which as evident in the August Institute for Purchasing Management data released Tuesday.

The stock market is undergoing its steepest correction since 2011, which also is no coincidence. As this column has noted on many occasions, the broad stock averages such as the Standard & Poor’s 500 have moved in tandem with the growth in the Fed’s balance sheet.

The 2011 correction came after the second phase of so-called quantitative easing ended and the balance sheet flat-lined. The market’s advance resumed with the commencement of the third phase, or QE3 the following year. QE3 ended late last year and the broad averages have given up their 2015 gains as the Fed’s balance sheet has shrunk slightly. What does that tell you?

Meanwhile, the economy looks less robust than the 3.7% annualized growth in real gross domestic product in the second quarter suggests. The Economic Cycle Research Institute’s weekly leading index, which provided signals of the second quarter’s rebound from the weather-affected first quarter, now is rolling over again.

The hoped-for second-half acceleration in growth is not developing, according to ECRI’s head, Lakshman Achuthan. While manufacturing is bottoming, the much-larger service sector is slowing. Overall, year-on-year growth in ECRI’s weekly gauge has dipped into negative territory.

The ECRI indicators last turned weak in the second half of 2012, when revised data show the economy was scraping by at a 0.25% growth rate—about as close to a recession as you can get without that official designation, Achuthan points out, even if it wasn’t evident in the numbers released at the time.

So, markets are teetering and the economic data are mixed. Other central banks, such as in Sweden and New Zealand, have lifted rates only to have to reverse themselves. That’s the last thing the Fed wants to do.

St. Augustine famously prayed for the Lord to grant him chastity, but not just yet. Would that he had a vote on the FOMC.


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