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Economic Research Published by Raymond James & Associates Scott J. Brown, Ph.D., (727) 567-2603, [email protected] August 22 - 26, 2016 Weekly Economic Monitor _______________________________________________________________________________________ Rethinking Monetary Policy Frameworks In late August, central bankers from around the world come to the Kansas City Fed’s annual monetary policy symposium. This year’s theme is “Designing Resilient Monetary Policy Frameworks for the Future.” In addressing the financial crisis and ensuing recovery, the Fed and other central banks have pulled out all the stops. This will be a chance to look back at the various elements (communications strategies, large-scale asset purchases, negative policy rates, etc.) with an eye to the future and how central banks can better prepare for future crises. At the July 26-27 Federal Open Market Committee, Fed officials were briefed by the staff on progress made in evaluating “potential long-run frameworks for monetary policy implementation.” This was a process that began a year earlier. Given the wide range of tools used by central banks in recent years, it’s worthwhile to evaluate their effectiveness and their drawbacks. No firm conclusions were reached in late July, and nothing is expected to be settled in Jackson Hole this week. The FOMC minutes noted that any decision regarding an appropriate long-run implementation framework “would not be necessary for some time,” but the discussion has begun. An economic downturn can be addressed through monetary policy or fiscal policy. Monetary policy is largely about changing short-term interest rates (the reserve requirement is not much of an option for the Fed), but we’ve seen other tools being used over the last decade, including large-scale asset purchases (what most people call “quantitative easing” or QE), special funding programs, and new communications strategies (forward guidance on rates). Fiscal policy refers to tax policy and to changes in government consumption and investment. The broad consensus among economists is that monetary policy is quick to implement but affects the economy with a long and variable lag. Fiscal policy, on the other hand, has a more immediate impact but is notoriously hard to implement (requiring an act of Congress). Most economists believe that you cannot fine-tune the economy with either fiscal or monetary policy. Both can be employed to help the economy out of recession, but monetary policy should do the “heavy lifting.” Monetary policy is often viewed as ineffective in the initial response to a downturn. Lower interest rates won’t stimulate capital spending if firms aren’t confident that demand for the goods and services they produce will recover, nor will low rates encourage consumer borrowing if individuals are worried about losing their jobs. Currently, the view that the Fed and other central banks are merely “pushing on a string” still seems to be a widespread concern. However, while monetary policy efforts do not guarantee a recovery, they do help to limit the damage during an economic downturn. Many of the Fed’s district bank presidents are worried about potential inflation in wages. Average hourly earnings rose 2.6% in the 12 months ending in July, but these officials worry that the job market has already tightened enough and, with monetary policy affecting the economy with a lag, it would be appropriate to move closer to neutral sooner rather than later. In mid-June, 6 of the 12 district banks had requested that the Fed’s Board of Governors increase the discount rate – and that was after a disappointing payroll report for May! The FOMC minutes showed that several Fed officials worried that an extended period of low interest rates risked intensifying investors to reach for yield and could lead to the misallocation of capital and mispricing of risk, with possible adverse consequences for financial stability down the line. As the Fed employed extraordinary measures to support the economy in recent years, it has consistently monitored the fixed income market for signs of excess. It’s likely that tighter credit spreads were one reason for the initial increase in short-term interest rates last December. Recall that credit spreads widened significantly in early 2016, but that was not entirely unwelcome in the Fed’s view. It largely reflected a re-pricing (or more correctly, a “right-pricing”) of credit. While Fed officials have not spoken much about this risk, it is almost certainly a factor in the Fed’s desire to resume policy normalization. Other Fed officials are worried that inflation will continue to undershoot the Fed’s 2% target. While prices of raw materials may have begun to firm up more recently, there’s no appreciable evidence of inflation in consumer goods (in fact, exfood and energy, the CPI for consumer goods is registering mild deflation). Pressure in services has largely been concentrated in shelter and medical care. These Fed officials are also aware of the asymmetry of policy errors. That is, it would be much harder for the Fed to correct course if it raises rates too rapidly than if it raises rates too slowly. There’s little cost to waiting. Above all these issues and concerns, Fed officials are also coming around to the idea that potential economic growth has slowed. The more moderate growth outlook is largely due to the slowing in labor force growth (a 1.8% annual rate from 1960-2000, +0.6% since 2000, and about 0.5% seen over the next ten years). Productivity growth has notably slowed over the last five years, but most Fed officials expect that to pick up. Regardless, the neutral Federal funds rate is lower now. Quarter after quarter, Fed officials have repeatedly revised lower their projected paths of the federal funds target rate. Their estimates of the long-term equilibrium rate have also declined. Expect these projections to edge lower again at the September FOMC meeting. Also, don’t expect any easy answers from Fed Chair Yellen’s speech at the end of the week. © 2016 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc. (RJA) as of the date stated above and are subject to change. Information has been obtained from third-party sources we consider reliable, but we do not guarantee that the facts cited in the foregoing report are accurate or complete. Other departments of RJA may have information that is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report that may not be consistent with the report's conclusions. JAclien isR Th h trasb International Headquarters: The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863 Raymond James Economic Research Treasury Yields 13-wk 26-wk 52-wk 7/22/16 8/12/16 8/19/16 0.33 0.29 0.44 0.43 0.55 0.56 Dollar 2-yr 3-yr 5-yr 10-yr 30-yr $/Euro 0.71 0.71 0.84 0.82 1.13 1.10 1.57 1.51 2.29 2.23 1.097 1.117 Recent Economic Data and Outlook Financial market participants were a bit cautious ahead of the Fed policy meeting minutes, fearful that officials would be anxious to raise short-term interest rates. However, while we didn’t learn much from the minutes, they were viewed largely as “dovish.” Industrial Production: Manufacturing (2012 = 100) 105 104 105 104 Manufacturing Ex-autos 103 103 102 102 101 101 100 100 99 99 Source: Federal Reserve 98 98 12 13 14 15 16 The FOMC Minutes from the July 26-27 monetary policy meeting showed that members “generally agreed that, before taking another step in removing monetary accommodation, it was prudent to accumulate more data in order to gauge the underlying momentum in the labor market and economic activity.” In the discussion, which included seven non-voting Fed district bank presidents, officials were mixed. “Many” felt that it was appropriate to wait for more information before raising rates. “Several’ suggested that there would be ample time to react if inflation rose more than anticipated. However, “some” officials thought that there has already been enough improvement in the job market. A “few” feared that the Fed would need to raise rates more rapidly if inflation picked up, and “several” worried that low interest rates would lead to a reach for yield “and could lead to the misallocation of capital and mispricing of risk, with possible adverse consequences for financial stability.” Industrial Production rose 0.7% in July (-0.5% y/y), boosted by hot weather and a possible quirk in the seasonal adjustment for autos. The output of utilities rose 2.1%, following a similar gain in June (+3.5% y/y). Mining rose 0.7% (-10.2%), with oil and gas well drilling (down 76% since late 2014) up 4.9% (suggesting a possible bottom in energy exploration). Manufacturing output rose 0.6% (+0.4% y/y), led by a 1.9% rise in motor vehicle production (down 20.5% before seasonal adjustment, reflecting more limited seasonal factory shutdowns, +1.8% y/y). Ex-autos, factory output rose 0.4% (flat year-over-year), with mixed results across major industries. $/BP Equities JY/$ 1.309 106.22 1.293 101.01 CD/$ NASD SPX DJIA 1.318 5100.16 2175.03 18570.85 1.294 5232.90 2184.05 18576.47 The Consumer Price Index was unchanged in July (-0.041% before rounding, +0.8% y/y), reflecting a 1.6% decline in energy prices (-10.9% y/y). Food was unchanged (+0.2%), split between a 0.2% decline in food at home (-1.6% y/y) and a 0.2% increase in food away from home (+2.8% y/y). Gasoline prices fell 4.7% (-5.5% before seasonal adjustment, -19.9% y/y). Ex-food & energy, the CPI rose 0.1% (+0.088% before rounding, +2.2% y/y). Shelter rose 0.2% (+3.3% y/y), held back by a 2.7% decline in lodging away from home (-1.5% before adjustment, unchanged y/y). Ex-food, energy, and shelter, the CPI was flat (+1.4% y/y). Real Hourly Earnings were unchanged in July, +1.7% y/y (+2.0% y/y for production workers). Building Permits edged down 0.1% in July to a 1.152 million seasonally adjusted annual rate (+0.9% y/y). Single-family permits fell 3.7% (+2.4% y/y), down in all four regions. Unadjusted permits for May-July were down 9.1% relative to the same period in 2015 (single-family +2.9%, multi-family -25.2%). Housing Starts rose 2.1% to a 1.211 million pace (+5.6% y/y), with single-family starts up 0.5% (+1.3% y/y). Homebuilder Sentiment rose to 60 in August, vs. 58 in July (revised from 59). Results were mixed across regions. The Index of Leading Economic Indicators rose 0.4% in July, following a 0.3% rise in June. An increase in the factory workweek, a higher stock market, and a positively-sloped yield curve made the largest positive contributions. A decrease in consumer expectations made the only subtraction. Economic Outlook (3Q16): about a 3.0% annual rate. Employment: Monthly payroll figures have been uneven. The underlying trend in private-sector payrolls remains relatively strong but slower than in the last couple of years. Consumers: Spending was strong in the first half of the year, but real income growth appears to have slowed. That may be temporary. Aggregate wage income improved in July. Manufacturing: Mixed across sectors in recent months but relatively soft overall, reflecting the contraction in energy exploration and the strong dollar’s impact on exports. Lean inventories suggest some potential for a pickup in production. Housing/Construction: Single-family construction has been trending higher, but multi-family activity has moderated following a very strong pace in 2015. Mortgage rates remain low, but home prices are rising (contributing to affordability issues). Credit for first-time buyers is still relatively tight. Prices: Core inflation appeared to be picking up in the first two months of the year, but March-June data show a moderate trend. Pipeline pressures are mild. Wage gains are moderate. Interest Rates: The Fed remains in tightening mode but is expected to proceed cautiously as it normalizes policy. Most Fed officials expect one or two 25-bp hikes by the end of 2016. © 2016 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. International Headquarters: The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863 2 Raymond James Economic Research This Week: forecast last Jul 580 -2.0 592 +3.5 Jul 5.55 -0.4 5.57 +1.1 8/20 Jul 265 +2.9% +0.2% -0.0% 262 -3.9% -0.4% +0.4% 2Q16 +1.2% +2.8% +0.8% +1.1% 90.6 90.0 Jul +0.6% +0.4% +0.1% +0.2% +0.4% +0.1% +0.2% led by a pickup in wage income +0.4% auto sales higher, gasoline prices down +0.1% core CPI rose 0.088% Consumer Confidence ADP Payroll Estimate, th. Chicago PM Index Pending Home Sales Index Aug Aug Aug Jul 97.8 +160 56.2 +0.6% 97.3 +179 55.8 +0.2% 97.4 +176 56.8 -3.7% range-bound likely to trend somewhat lower moderate a bit choppy, but a moderate trend Jobless Claims, th. Construction Spending ISM Manf. Index Motor Vehicle Sales, mln domestically built 8:30 Nonfarm Payrolls, th. private-sector Unemployment Rate employment/population Avg. Weekly Hours Avg. Hourly Earnings 8:30 Trade Balance, $bln goods only 10:00 Factory Orders 8/27 Jul Aug Aug 265 NF 53.4 NF NF +150 +165 4.8% 59.8% 34.5 +0.2% -42.5 -64.0 NF 265 -0.6% 52.6 17.8 13.8 +255 +217 4.9% 59.7% 34.5 +0.3% -44.5 -66.0 -1.8% 266 -0.1% 53.2 16.7 12.8 +292 +259 4.9% 59.6% 34.4 +0.1% -41.0 -62.2 -1.6% trending low an unexpectedly soft trend in 2Q16 mixed, but likely moderate likely to pull back following strong July underlying trend should be flattening government likely to pull back somewhat likely to post a more moderate increase mostly steady edging higher seen steady moderate wage pressures seen narrower reflecting lower petroleum prices a soft trend Monday 8/22 no significant data Tuesday 8/23 Wednesday 8/24 10:00 New Home Sales, th. % change 1:00 Treasury Note Auction 10:00 Existing Home Sales, mln % change 11:30 Treasury FRN Auction 1:00 Treasury Note Auction Thursday 8/25 Friday 8/26 8:30 Jobless Claims, th. 8:30 Durable Goods Orders ex-transportation nondef cap gds ex-aircraft 1:00 Treasury Note Auction nd 8:30 Real GDP (2 estimate) Priv Dom Final Purchases 8:30 Adv. Economic Indicators 10:00 UM Consumer Sentiment 10:00 Janet Yellen speaks last –1 comments John Lee Hooker (b. 1917) Jul Aug 572 these data are erratic 0.0 but the underlying trend is strong $26 billion in 2-year notes 5.51 likely to be little changed +1.5 trend is strong $13 billion in re-opened 2-year FRNs $34 billion in 5-year notes 266 -2.9% -0.5% -0.6% trending low expecting a rebound in aircraft orders a weak trend seen about flat $28 billion in 7-year note +0.9% +1.2% in the advance estimate +1.8% +2.7% in the advance estimate July foreign trade in goods, inventories 93.5 90.4 at mid-month “Federal Reserve's Monetary Policy Toolkit” Next Week: Monday 8/29 8:30 Personal Income Personal Spending PCE Price Index ex-f&e Tuesday Wednesday 8/30 8/31 10:00 8:15 9:45 10:00 Thursday 9/01 8:30 10:00 10:00 tbd Friday 9/02 Aug Jul Jul This Week… Financial market participants may react to any surprises in the economic data reports, but there’s nothing that will add much to the overall economic outlook. Instead, the focus will be on Janet Yellen’s Jackson Hole speech. The Fed chair is unlikely to provide any clear signals about what policymakers will do at the September 20-21 policy meeting. Instead, expect a general discussion of monetary policy frameworks – the importance of flexibility and clear communications, the strengths and weaknesses of large-scale asset purchases, and issues surrounding negative policy rates (not that the Fed expects to go there anytime soon). The Fed and central banks have done a lot of things during and after the financial crisis, and it’s worth sorting all that out to better plan for the next major crisis. Monday No significant data. Tuesday New Home Sales, th. 1400 1400 1200 1200 1000 1000 800 800 New Home Sales For Sale 600 600 400 400 200 200 Source: Bureau of Census 0 0 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 © 2016 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. International Headquarters: The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863 3 Raymond James Economic Research New Home Sales (July) – The government’s home sales figures are reported with such a huge degree of statistical uncertainty, it’s a wonder that they even publish them. The data are choppy and subject to large revision, but the underlying trend is higher. Contributions To U.S. GDP Growth, % 6 6 Pers. Spd. Resid. Inv. Exports Ch. Invent. 5 4 Bus. Inv. Gov't Imports Real GDP 5 4 Wednesday 3 3 Existing Home Sales (July) – In contrast to new home sales 2 2 1 1 0 0 -1 -1 -2 -2 figures, which have yet to rebound to pre-bubble levels, existing home sales have been relatively strong in recent months. However, there is still plenty of variability (partly reflecting the difficulty of adjusting for the strong seasonal pattern). Existing Home Sales and Pending Home Sales Index, th. 130 6500 -3 Pending Home Sales Index (left) 6000 Existing Home Sales (right) 120 -3 Source: BEA -4 -4 14.1 14.2 14.3 14.4 15.1 15.2 15.3 15.4 16.1 16.2 16.3 16.4 5500 Advance Economic indicators (July) – Inventory and foreign trade 110 5000 100 4500 4000 90 3500 80 3000 Source: National Association of Realtors 70 2500 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Thursday Jobless Claims (week ending August 20) – Initial claims for unemployment benefits have been below 300,000 for the last 76 weeks, the longest string since 1970. Durable Goods Orders (July) – Monthly changes in orders tend to be choppy. The underlying trend over the last several quarters has been soft but not “recessionary.” We should see a rebound in aircraft orders leading the headline figure higher in July. Durable Goods Orders, y/y % change 20 20 15 15 10 10 5 5 0 0 -5 -5 -10 -15 nondef. capital goods, ex-aircraft durable goods, ex-transportation -20 figures for July will help to refine forecasts of 3Q15 GDP growth, but financial market participants will likely pay no attention. Yellen Jackson Hole Speech – Over the years, the Fed Chairman’s Jackson Hole speech has often been market-moving but just as often not. The theme of this year’s monetary policy symposium is “Designing Resilient Monetary Policy Frameworks for the Future.” We know that Fed officials are split, but the hawkish view (those wanting to raise rates sooner rather than later) is a small minority of the Federal Open Market Committee members (those that actually vote on policy). Most likely, Yellen will want the FOMC to keep its options open for September. Next Week … Another month, another payroll report. The strong gains of June and July made almost everyone forget the poor May figure. However, they may simply reflect noise in the data – the trend in job growth, while still moderately strong, has slowed somewhat relative to the last couple of years. That may reflect greater business caution, or tighter job market conditions, or a combination. Expect a quick market reaction to the jobs data as market participants look to a three-day weekend (and the start of the college football season). Coming Events and Data Releases September 5 Labor Day Holiday (markets closed) -10 September 6 ISM Non-Manufacturing Index (August) -15 September 15 Retail Sales (August) -20 September 21 FOMC Policy Decision, revised Fed projections, Yellen press conference -25 -25 -30 -30 September 26 1 Presidential Debate (Hempstead, NY) -35 October 9 2 Presidential Debate (St. Louis, MO) October 19 3 Presidential Debate (Las Vegas, NV) November 2 FOMC Policy Decision (no press conference) November 8 Election Day December 14 FOMC Policy Decision, Yellen press conference Source: Census Bureau -35 05 06 07 08 09 10 11 12 13 14 15 16 Friday Real GDP (2Q16, 2nd estimate) – The 2 nd estimate can differ a lot from the advance figure. However, component revisions appear to have about balanced out on average (inventories likely did not fall as much as in the initial estimate, while net exports are expected to subtract). Data will be revised again next month. st nd rd © 2016 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. International Headquarters: The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863 4