Bi-Weekly Economic Review: Is The Fed Behind The Curve?

Economic Reports Scorecard

There was little improvement in the economic data the last couple of weeks, the Citigroup Economic Surprise index still well below zero (-8.1). And frankly, where there was improvement such as the GDP report, it doesn’t look sustainable…unless the US is about to become a soybean exporting powerhouse. Anything is possible I suppose but counting on Brazil to have a lousy soybean crop every year doesn’t sound like much of a growth plan. Neither does add to inventories when shelves are already more than fully stocked, inventory to sales ratios at recession levels. 

I said in the last report that it appeared that, based on what we were seeing in the bond market, real growth expectations were rising. It took a mere two weeks to make me look a fool on that front. Bonds have continued to sell off but it is nominal bonds leading the way with TIPS outperforming. In other words, the bond selloff isn’t about real growth, it is about inflation fears. Those fears have been bolstered by some data such as the Case-Shiller and FHFA house price indexes (+5.1% and 6.4% YOY respectively), a CPI that is rising closer to the Fed’s alleged target and the Employment Cost Index, up 2.2% YOY. But more than that I think is the new meme coming out of the Fed about allowing the economy to “run hot” for a while to make up for lost ground in the inflation indices. Janet Yellen, in a recent speech, touted the supposed benefits of operating a “high-pressure economy”, one with inflation higher and unemployment lower than what the Fed believes to be appropriate in normal times. 

Of course, this tradeoff between inflation and unemployment is one that, while oft alleged, has been tough to see in a real, actual economy. The alleged benefits of a high-pressure economy are so extensive – raise consumer spending and business investment, raise the labor participation rate, increase R&D spending and new business formation according to Yellen – that to not pursue them would seem to be monetary malpractice. Of course, all the reckonin’, allowin’ and speculatin’ (as my father used to say) about such a high-pressure economy presumes that the two variables are in some way linked and can be easily controlled by the Fed. The market seems to have no problem believing the Fed will let inflation run beyond its target but is much more skeptical about any benefit to the real economy.