by Lance Roberts, Clarity Financial
Data Says Fed Is Making A Mistake
In their policy announcement last week, the members of the FOMC claimed:
“Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year.”
Economic data has continued to remain extremely soft given the rise in confidence. We addressed previously that while the “soft data” was hitting the highest levels seen since the “Great Recession,” actual economic activity had failed to catch up. As noted on last week:
“For the 13th straight week, US economic data disappointed (already downgraded) expectations, sending Citi’s US Macro Surprise Index to its weakest since August 2011 (crashing at a pace only beaten by the periods surrounding Lehman and the US ratings downgrade). The last time, Us economic data disappointed this much, Ben Bernanke immediately unleashed Operation Twist… but this time Janet Yellen is hiking rates and unwinding the balance sheet?”
This is quite confusing, considering the Fed is supposed to be “data dependent.” Ever since 2011, I have tracked the Fed’s economic forecasts relative to reality. If they are using economic data to guide their forecasts and policy actions, the following table and graph should scare you.
However, despite the clear evidence that economic growth is hardly running at levels that would be considered “strong” by any measure, the Fed is “tightening” monetary policy. This is ironic considering the ENTIRE PURPOSE of TIGHTENING monetary policy is to SLOW economic growth to keep inflationary pressures at bay.
Neal Kashkari also noted the disconnect between Fed policy and the economy:
“At the same time the unemployment rate was dropping, core inflation was also dropping, and inflation expectations remained flat to slightly down at very low levels. We don’t yet know if that drop in core inflation is transitory. In short, the economy is sending mixed signals: a tight labor market and weakening inflation.”
Kashkari is right in worrying that the Fed is placing too much faith on the Phillips Curve which predicts a tighter reverse relationship between the unemployment rate and inflation than has actually been seen in recent years. This is particularly the case given the problems with the underlying U-3 employment rate calculation as discussed just recently. To wit:
“The Bureau of Labor Statistics (BLS) has been systemically overstating the number of jobs created, especially in the current economic cycle. Furthermore, the BLS has failed to account for the rise in part-time and contractual work arrangements, while all evidence points to a significant and rapid increase in the so-called contingent workforce as full-time jobs are being replaced by part-time positions, resulting in double and triple counting of jobs via the Establishment Survey.
Lastly, a full 93% of the new jobs reported since 2008 and 40% of the jobs in 2016 alone were added through the business birth and death model – a highly controversial model which is not supported by the data. On the contrary, all data on establishment births and deaths point to an ongoing decrease in entrepreneurship.”
Neal goes on to identify the risk:
“In the 1970s, that faith led the Fed to keep rates too low, leading to very high inflation. Today, that same faith may be leading the Committee to repeatedly (and erroneously) forecast increasing inflation, resulting in us raising rates too quickly and continuing to undershoot our inflation target.”