What About Waller?

19 members, 38 views

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With all the chatter coming out of the FOMC, sometimes it is hard to separate the news from the noise. The “information” flow is unrelenting, including speeches from all 19 members of the Committee, comments from other senior officials, and a flow of research papers coming out of 13 research teams. Moreover, an important part of the job of the regional Presidents is to give speeches across their district—whether they have something new to say or not.

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This high volume of information is met by an eager audience. Investors are on high alert for any small hawkish or dovish sound coming out of the Fed. After many years as a Fed watcher I’m still struck at how much the markets can move on morsel of Fed news. A large press core follows these folks, looking for something interesting to say as they compete for eyeballs. I’ve never seen a press report titled: “FOMC Member Gives Same Speech as Two Weeks Ago.”

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Separating the wheat from the chaff

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Based on my experience, here are some suggestions on how to sort through this stuff:

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• ·????? First, as I have written before, following the Fed is not a vote counting exercise. Policy making is a consensus forming process where there is considerable deference to the chair and good arguments carry weight.
• A corollary of this is that dissents are a bit of a side-show. There has not been a close vote in many decades.
• Focus on the median or the central tendency of the Committee, not the average. By that I mean, the most hawkish and dovish members don’t drive policy, it is the center of the distribution that matters (again, with the chair getting “more than one vote”).
• When a member gives (almost) identical speeches over a relatively short time frame, ignore the second speech. Most of the time the fact that the speech hasn’t changed reflects the fact that these are very busy people, not that they are dismissing recent news.
• Beyond the Chair, give more weight to the Vice Chair and the NY Fed President who tend to have the most interaction with the Chair.
• For other members of the Committee, I focus on the weight of their argument. Are they offering a new insight such as examining a key relationship, or is the speech basically a summary of recent news with a hawk- or dove-leaning bottom line. The former will both inform my own view and have a bigger impact on the consensus of the Committee.
• Last and perhaps most important, do you agree with the forecast or characterization of the data that the speaker offers? No one on the Committee disputes the basic goals of the Fed—maximum employment and 2% PCE inflation. What they disagree on is how those goals will be achieved—quickly or slowly and with what tradeoffs.

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Where’s Waller?

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This brings us to Waller’s dovish drift. Clearly Waller carries some weight on the Committee. He has the right background for being an effective monetary policy maker, having run the research department at the St. Louis Fed for a decade. Equally important, his speeches go beyond describing trends in the economy and offering broad policy advice and delve into key questions of the day. I learn from his speeches, and I bet his fellow Fed folks do as well.

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Waller has pivoted from hawkish to dovish in the last month. In a speech a October, "Something's Got to Give," he seemed concerned that the economy was too strong to bring inflation back to target. Yesterday, referring back to that speech, he said “It seemed clear to me then that something had to give— for inflation to continue falling to our 2 percent target, the economy needed to slow from its torrid third-quarter pace. If it did not cool off, then it was likely that progress on inflation would stop or even reverse. So, what remained to be seen was whether the economy would cool or inflation would heat up.”

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Now he believes that " Something Appears to Be Giving.” Specifically, “data for October indicated an easing in economic activity, and forecasts for the fourth quarter show the kind of moderation that is more in keeping with progress on lowering inflation. In addition, after watching core PCE inflation increase in September from its summer lows, the latest data showed inflation moving in the right direction in October, albeit gradually.”

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I’m More Worried Than Waller

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In my view it is too early to argue that the economy is cooling off sufficiently. As I noted in a post yesterday, the impact of financial tightening on GDP growth (not level) is likely happening now, rather than getting stronger going forward.

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I wouldn’t take much comfort from the GDP data. The 5.2% surge in 3Q GDP was clearly unsustainable, and the consensus sees a major slowing in 4Q. Averaging the two, growth is running at 3% or so. That’s still a fairly hot economy,

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The monthly data suggest some weakening in October and perhaps that is the beginning of more convincing weakness. However, I like to look at three-month averages to gauge near-term trends. That is a short enough period to spot turning points and a long enough period to eliminate a lot of the monthly noise. In the past three months payroll growth has averaged 204k or about the same as the 207k three months earlier. The “control” measure of retail sales is also growing at a steady pace. The unemployment rate seems to be inching higher despite the solid payrolls. Going deeper down the list, housing starts have reweakened, manufacturing output is essentially flat, auto sales have stopped rising, and the composite ISM index is on the low end of its range in the past year or so. Growth seems to be weakening a bit, I’m not convinced it will be enough to induce a Fed cut in the Spring.

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I also have more a of glass half empty view of progress on inflation. As my (patient) readers know, I’m a big fan of median and trimmed mean inflation, as they strip out all the weird stuff and are calculated automatically rather than at the discretion of the economist. It is true that October looks a lot better than September on a month-over-month basis. But for the most part recent data seems sticky strong. On a 3-month annualized basis median PCE inflation is running at 3.2% and trimmed mean is running at 3.5%, with both bouncing slightly off their lows. The corresponding CPI data is higher and has a more noticeable upswing. Of course, the hope is that weaker rent and OER will come to the rescue, but even for these components the most recent data are a bit disappointing. ?Hopefully the downtrend in true core inflation resumes but I’m not confident about that.

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In sum: If Waller’s forecast/scenario is right the Fed will probably cut in the spring. If growth and/or inflation are stickier than he expects, they will likely wait. Either this is a lot more interesting than watching a Patriots-Giants game.