The Fed Is in Limbo


by Jim Rickards, Daily Reckoning:

In yesterday’s analysis, I compared Janet Yellen to an athlete running the high-hurdles at a track meet. Her finish line is a rate hike on December 13.

The hurdles are inflation data, the Trump tax cut, and a government shutdown on December 8. She has to clear all three hurdles to make it to the finish line.

These hurdles are all conveniently time-stamped. The inflation data came out this morning, the tax bill vote is scheduled for Friday, and the government shutdown is scheduled for next Friday, December 8.

As New York Mayor Ed Koch used to ask, “How am I doin’?”

Well, the inflation data this morning was decisively… indecisive.

The particular metric in focus was the personal consumption expenditure core deflator on a year-over-year basis released monthly by the Commerce Department with a one-month lag. Call it PCE Core year-over-year for short.

Sounds technical, but it’s important because that’s the number the Fed watches. There are plenty of other inflation readings out there (CPI, PPI, core, non-core, trimmed mean, etc), but PCE Core year-over-year is the one the Fed uses to benchmark their performance in terms of their inflation goal.

The Fed’s target for PCE Core is 2%. The October reading released this morning was 1.4%. For weeks I’ve been saying that a 1.3% reading would put the rate hike on hold, and a 1.6% reading would make the rate hike a done deal. So, the actual reading of 1.4% was in the mushy middle of that easy-to-forecast range.

What’s interesting is that the prior month was also 1.4%, so the new number is unchanged from September. That’s not what the Fed wants to see. They want to see progress toward their 2% goal.

On the other hand, the 1.4% from September was a revised number. It was earlier reported at 1.3% (the same number as August).

You can read this two ways. If you see the August 1.3% as a low, then you can say the 1.4% readings for September and October were progress toward the Fed’s 2% target. It’s a thin reed, but Yellen could use this to justify her view that the year-long weakness in PCE Core is “transitory.”

On the other hand, these 0.1% moves month-to-month are really statistical noise and may even be due to rounding. The bigger picture is that PCE Core is weak and nowhere near the Fed’s target. Another rate hike in December could be a huge blunder if it slows the economy further and leads to more weakness in PCE Core.

On balance, the PCE Core number is probably just enough (barely) to justify a rate hike. I’ve raised my probability of a December rate hike from 30% to 55%. That’s what good Bayesians do; they update forecasts continually based on new data.

Of course, the market has been pricing in at a 100% probability for a few weeks. That’s fine, markets have been wildly wrong in the past. I’d rather stick with a good model and update continually than swing from one extreme to the other based on crowd behavior. My Bayesian statistical models (along with other scientific tools) have served me well for a long time and I’m sticking with them.

As John Maynard Keynes said, “When the facts change, I change my mind. What do you do, sir?” (Actually Keynes never said that, but it’s a wonderful quote attributed to him. Keynes would certainly agree).

What about the remaining two hurdles for our track-star Janet Yellen?

The tax bill vote is scheduled for Friday. If it passes the Senate, it will almost certainly become law in the next few weeks after the House and Senate versions are reconciled.

The stock market has already priced in a tax cut. Markets won’t go up much more if the bill passes because they already expect it to pass. But if the bill fails markets could plunge on the bad news.

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