As we expected here at Cumberland Advisors, the FOMC chose not to raise rates at its September meeting but strongly suggested, based upon both rhetoric and its dot forecast chart, that it was clearly open to one policy move this year. However, the case made both in the Committee’s Statement and by Chair Yellen at her press conference was represented as being stronger than an unbiased observer could justify by the available data.
As expected, someone asked at the press conference whether the November meeting was a “live” meeting or not. Predictably, Yellen repeated the mantra that all meetings were live. But realistically, the November meeting falls just before the election, no new forecasts will be prepared and no press conference is currently scheduled, so it would take a surprising turn of the incoming data to trigger a policy move at that meeting. At that meeting, the Committee will have the first reading on Q3 GDP, one more jobs report and two readings on PCE inflation. So far, the incoming numbers on Q3 GDP suggest another quarter of sluggish or moderate growth. Hence, we aren’t likely to see a move until December.
Jobs, Jobs, Jobs
What did the Committee say on Wednesday besides projecting the view that it was close to making a decision to raise rates again? The first data point that the Committee statement focused on was the labor market. While the unemployment rate has remained steady, Yellen emphasized that more people have entered the job and labor market, which has continued to strengthen. Though she did acknowledge that growth thus far in 2016 has been less robust than in 2015, her case is not as strong as she would like to make it appear. Current job-market performance, relative to past history, is in fact dismal. Job growth may be enough, as Yellen argued, to absorb new entrants into the market, but certainly not enough to also provide jobs for those with part-time jobs who want full-time work. By comparison, we estimate that if today’s economy created the same number of jobs per dollar of GDP that it did between 1960 and 1970, for example, job growth today would be four times what it currently is. Similarly, the number would be twice as large if the jobs creation rate today were what it was in 1983–2006.
Chair Yellen also said that economic growth had picked up from the “modest” pace of the first half of the year. Remember that the last three quarters saw GDP growth that never exceeded 1.1%; and while consumer spending was strong in July, subsequent data suggest some moderation may be afoot. Household income did improve according to the latest data release, but information from the Fed’s Beige Book suggests that growth is still not robust. Furthermore, business investment, the engine of job growth, has stagnated. Additionally, the Chicago Fed’s national business index and its four key components all declined in August -- information that had to be known at the FOMC’s meeting. This performance is reflected in the significant markdown in the Committee’s Summary of Economic Projections (SEP) for the second half of the year as compared with its June forecast. Finally, the Committee noted that inflation is still running below target, a shortfall again partially rationalized away as being a transitory result of the lasting decline in energy prices. But this, too, is a stretch, since energy prices have remained relatively flat for the past three months.
Looking forward, the Committee’s SEP projections appear to be contradictory. For example, both in 2015 and this year, projected GDP growth has been continually marked down for both 2016 and 2017. Q4 growth implied by the forecast is not much above 2%. This pattern, combined with a largely unchanged unemployment situation and an inflation forecast that hovers below target through 2019, makes it hard to rationalize the Committee’s stated view that inflation will be pushed back toward target in a meaningful way. In the forecasts, aggregate demand is not sufficient to push prices up significantly. For demand to hold, there must be a resurgence in the Committee’s real-side Phillips curve view that increases in wages, when and if they come, will drive up prices. That model has performed poorly over the past several years; in fact, a simple regression relating inflation to the unemployment rate since 2010 has the wrong sign.
Not Observable
So, while the Committee is increasingly concerned about the need to restore policy to a more normal stance, it is struggling to understand what the neutral interest rate is or should be. This is compounded by the fact that that rate, like the natural rate of unemployment, is not observable. That struggle has been apparent in the public statements by several Reserve Bank presidents and board members. It was heightened by the three dissents at Wednesday’s meeting. Presidents Mester and Rosengren have now joined President George in dissenting from the majority statement. Yellen was questioned about the dissents and she rightly pointed out that the divergence of views was a positive indication that there was a healthy exchange of views during the meeting and that it helped to avoid “group think.” So, while the Committee may want to begin restoring interest rates to a more normal level, in the face of ongoing uncertainty, it decided to wait a bit longer before acting.