Crossing Wall Street Review – September 8, 2017
What’s Next for the Federal Reserve?
By Eddy Elfenbein, editor of Crossing Wall Street and portfolio manager of the AdvisorShares Focused Equity ETF (NYSE Arca: CWS)
Stanley Fischer, the vice-chair of the Federal Reserve, announced this week that he’s stepping down next month. This brings us to an unusual moment for the Fed, since there will be four vacancies on the Federal Reserve Board. By law, the FRB has seven slots. By my math, this means that the labor force participation rate for Fed governors is only 43%.
It will soon go even lower, since Janet Yellen’s term as Fed chair ends in February. This gives President Trump a big opportunity to put his stamp on the Fed. Officially, Trump has not ruled out reappointing Janet Yellen to another term as Fed chair, but that probably won’t happen. She recently defended some of the post-crisis financial regulations which Trump has promised to repeal.
Quick side note: The appointments to the Fed and of the Fed chair are separate presidential appointments. So if President Trump doesn’t reappoint Yellen as chair, she would still be a Fed member. However, it’s generally assumed she would resign if she were no longer Fed chair.
Fed watchers had assumed that Gary Cohn was Trump’s top choice to replace Janet Yellen. But this week, the Dow Jones reported that it’s “unlikely” Cohn will get the nod, due to his criticisms of the president’s response to the terrible events in Charlottesville. Jake Tapper tweeted that one White House source said that Cohn was more likely to get the electric chair than the Fed chair. Ouch.
So who’s next for the position of Fed Poobah? A few names have been thrown around. I would guess that John Taylor at Stanford would be a front runner. He’s widely known for the “Taylor Rule,” which is a guideline for determining where interest rates should be. Frankly, I’m a skeptic on these rules. They’re great in theory, but I’m not sure how they work in real time. But there’s no doubt that Taylor is a highly qualified choice. Some other contenders are Kevin Warsh, Glenn Hubbard and Jerome Powell.
President Trump has described himself as a “low-interest-rate person,” but I doubt he’s very ideological on monetary matters. This is an important time for the Fed. The central bank wants to unwind its gigantic balance sheet at the same time it’s looking to raise interest rates. It’s not an easy task. With low rates, that weakens the dollar. The euro is near a 33-month high versus the greenback.
I’ve been critical of the Fed lately, because I think they’ve moved too quickly on rates. Lately, however, I think the Fed is coming around to my side (more on that in a bit). I think the Fed will remain on a pragmatic and accommodative course over the next few years, and that’s good for investors.
The U.S. Economy Is Gaining Strength
Speaking of the Fed, last Friday we got the August jobs report. It was on the weak side, but nothing too dramatic. Last month, the U.S. economy created 156,000 net new jobs. The numbers for June and July were revised downward. The unemployment rate ticked up to 4.4%, but it’s still near a 16-year low. For the most part, the U.S. economy has created an average of 200,000 jobs a month every month for the last seven years. The numbers haven’t deviated very far from that trend.
While this report wasn’t that bad, I think it finally clued in the bond market that the Fed isn’t going to move on interest rates anytime soon. The equation is simple. When someone asks, “Are stocks cheap?,” the answer is always, “Compared with what?” (Yes, we answer questions with questions.) That’s why interests are so important to equity valuations.
Last Thursday, the government released personal-income and spending numbers for July. That report includes the PCE price index, which is the Fed’s preferred measure for tracking inflation. The core PCE number for July rose by just 0.1%. It was the same in June. For the past year, core PCE is up 1.4%. In other words, inflation is hardly a problem. Next week, we’ll get the CPI report for August, and I expect to see much of the same.
With so little happening with inflation the Fed may be convinced to back down. The FOMC is set to meet again on September 20, and I strongly doubt they’ll do anything. The futures market thinks there’s only a 26% chance the Fed will raise rates before the end of the year. I’d say that’s about 20% too high. The Fed funds futures are now priced to show a 54% chance of no rate hike in the next 12 months. That’s a stunning reversal of sentiment. Late last year, the Fed was calling for three hikes this year, plus three more in 2018 and three more in 2019. All that’s gone now.
One potential roadblock for the economy could be the impact of Harvey and Irma. We don’t know yet the full measure of these events. On Thursday, we got our first glimpse of what Harvey could mean. Initial jobless claims soared to 298,000. That’s a rise of 62,000. As a metric, initial jobless claims have the benefit of being early, but that’s at the expense of being noisy. We saw similar jumps with previous storms.
The recent economic numbers look quite good. Q2 GDP came in at 3%. Last week, we learned that personal income rose by 0.4% in July while personal spending rose by 0.3%. That’s quite good. Also, Friday’s ISM report was the best in six years. This suggests the economy got off to a strong start for Q3. The Atlanta Fed’s GDPNow model now says that Q3 GDP grew by 3.3%. I’m wary of such models, but I hope that number is right.
The information, statements, views, and opinions included in this publication are based on sources (both internal and external sources) considered to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Such information, statements, views and opinions are expressed as of the date of publication, are subject to change without further notice and do not constitute a solicitation for the purchase or sale of any investment referenced in the publication.