Naughty or nice? What will the Fed do about the recovery next week?

In a normal recovery, key indicators generally tell a similar story. Now is not normal. Covid is signal jamming the U.S. economy, and it's up to the Fed to make sense of it.

Next week Jay Powell will explain what he and the Federal Open Market Committee will do next. As Ben Bernanke likes to say with a huff, “Good luck with that.”

Every press conference now is Jay’s most important. It’s an impossible task, and he’ll wobble some. So, what’s the Fed to do? Lean hard, very hard on the data.

I learned how to use data at the Fed. I’m not there anymore—spared from the endless editing meetings—but I do think about the process a lot. What data would so-and-so look at? What would such-and-such think? What are this and that arguing about?

In my last post, I shared data on jobs, spending, inflation, investment, and household balance sheets in my last post. I didn’t just slap down numbers. I laid out a story. That’s how I was trained and it’s a good, evidence-based approach.

Sugarplums or lumps of coal from Jolly Ol’ Jay?

The holiday parties are back this year. The vaccinated, tested, and masked will be safely together in small groups, unlike last year. Now think about the recovery.

The Fed’s job is to make sure that the party is jolly but not too jolly. (They practice what they preach. The Board’s holiday party is kiddie punch only. Sugar highs are possible if you can get one of the cookies.)

The recovery is a rockin,’ though not always in a good way. It’s hard to tell if that awful karaoke song will end soon (be transitory) or go on for hours more. It’s hard to tell how many people will get on the dance floor (broad-based and inclusive).

Next week the Fed will remind us they are watching careful and while it’s hard tell, they think it might be ready to turn the music down a bit, not off, but down.

In Fedspeak, I expect the FOMC’s statement to read:

“the Committee decided to begin reducing the monthly pace of its net asset purchases by $10 billion $20 billion for Treasury securities and $5 billion $10 billion for agency mortgage-backed securities. Beginning later this month in January, the Committee will increase its holdings of Treasury securities by at least $70 billion $50 billion per month and of agency mortgage-backed securities by at least $35 billion $25 billion per month. Beginning in December February, the Committee will increase its holdings of Treasury securities by at least $60 billion $30 billion per month and of agency mortgage-backed securities by at least $30 billion $15 billion per month. 

If they keep that pace, March, not June, will be the last month that the Fed purchases these assets. Then their next tool will most likely be raising the federal funds rate.

I doubt any of that will matter much for inflation or jobs. (Markets will have ‘fun’ with it.) Even if borrowing costs via lower interest rates rise some, which is their goal, people will still spend, and businesses invest.¹ Maybe a tiny bit less, but not much of a change. The party will go on. Moreover, the Fed can’t shut the karaoke machine off without pulling the plug on the party. (They won’t unless they absolutley have to.)

So a bit less sugarplums, a bit less music, but no lumps of coal. Exception: anti-vaxxers, spreaders of misinformation about Covid, fearmongers on the economy (you know who you are), they get coal.

Join the holiday-party press conference.

If I have piqued your interest in what the Fed is up to, watch the press conference next Wednesday at 2:30 pm ET on the Fed’s YouTube channel.

To make it extra fun, I made a bingo so that you can play along at home. Cheers!

What’s up with inflation, the big party pooper?

Tomorrow the inflation hawks will be singing off-pitch at the top of their lungs. Larry will have the microphone to the karaoke machine and there’s nothing we can do about it, at least, not yet. Hang in there.

The Consumer Price Index tomorrow will almost certainly show a big increase in prices in November, albeit less than in October. I am disappointed but not entirely surprised. (More so with vaccination rates.) Covid is making it very hard to understand what’s going on and what’s next. So, I keep going back to the data.

I wrote earlier this week on a whole range of data. I will underscore here the point that inflation-adjusted spending is rising more than consumer prices. That’s good and very different from the stagflation of the 1970s. But, just because most people are able to handle the higher inflation now does guarantee that will be the case if it remains high. It’s very important to think hard about where inflation is likely headed.

To do so, let’s look under the hood at inflation.

The 12-month percent change in prices in the detailed categories in the Personal Consumption Index—the Fed’s target series—shows that some categories have experienced big swings in prices. That’s not new to Covid. It’s just that currently, we have several categories moving up a lot, and not just the usual suspects.

We can’t chalk up the higher inflation now to used car prices and semiconductor shortages. Various Fed officials last week, including Powell, said they see signs of Covid-related inflation spreading to non-Covid-related categories. Of course, Covid-related and what’s not is a judgment call.

To drill down more and look at the underlying pace across, I removed ones with more than a 10% increase or 10% decrease at any point in the period. (See chart note.) I also excluded all food or energy goods and services.

Looks, like a party, right? Please, remember this chart tomorrow when you hear pundits go on and on about two numbers from the CPI: total and core. It should not be this way. The U.S. economy is incredibly dynamic. There’s always a lot going on under the hood. The details matter so does the underlying push and pull.

If you squint, it looks like the mass of inflation is drifting up this year, not that much, in my opinion. Not like Covid cases. I have looked at other analyses, see two great resources from the San Francisco Fed here and here. I think the Fed official overdid it a bit with their inflation-worried remarks recently. But I know why the Fed must (and should) sound more concerned. Plus, the labor market recovery is really moving along. When their mandate is met, or as best they can, then it will be time to raise rates.

Wrapping Up

Tomorrow is Inflation Day (ugh) and next week is Fed Week (yippee).

There is a lot going on in the world right now. The signals from the economy are confusing and without precedent. The Fed does not have a crystal ball. though many in markets and policy circles mistakenly act as if they do.

What the Fed does have is an unparalleled ability to sift through and interpret an endless stream of data and then use it to determine what it should do next.

It sounds quaint and is true the Fed is “not on a preset course.” They will react to events in the world, not make the world confirm its prior views. That’s the most we can ask from our policy makers. That, and humility. Lots of humility.

PS I will write a post for paid subscribers only on Monday with more on the Fed’s upcoming meeting, especially what to expect in the Summary of Economic Projections from FOMC participants, which includes the infamous dot plot. (I hate the dot plot, but it’s a thing, so I talk about it.)

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1. Note well; the Fed does not control rates, even though it’s the Fed’s main policy tool. Just because they want the rate not to be so low does not mean they get it. There’s much more for markets to react to (hi, Omicron!), so borrowing costs might fall more and stoke demand. Moreover, there’s disagreement about exactly how the asset purchases, aka quantitative easing, affect the economy, but my explanation is the Fed’s go-to.