Wolf Richter: My Fancy-Schmancy “Fed Hawk-o-Meter” Ticks Down, Still Red-Lines. In Passing, Fed Plants Seed for Removing “Patient”

Yves here. It is disheartening to see the degree to which the Fed has embraced mission creep and then has proven not to be very good at it. It was bad enough that Paul Volcker weakened the Fed’s commitment to full employment by taking the position that any inflation is too much inflation, and using construction wages as his measure. What hurts investors is not inflation per se (as long as it is not so high as to make financial statements unreliable). Investors are perfectly capable of pricing in an inflation rate of, say, 2% or 4%. What hurts them are interest rate increases, and above all, sudden and unexpected ones.

However, the Greenspan Fed cared about the stock market and institutionalized the “Greenspan put” of having the central bank run to the rescue of investors, via lowering interest rates, at any sign of trouble. This reduced the risk of investing in financial assets relative to real economy projects, increasing speculation and over-financizalization of the economy. Some economists have argued that Greenspan’s overreaction to the dot bomb era (keeping interest rates negative in real terms for an unprecedented nine quarters) made the housing bubble worse.

The latest sign of the Fed’s misaligned priorities is its view that the economy is (or at least was) strong, based on unemployment data. However, wage gains have been weak, and the reason why is that we still have high levels of involuntary part time work. The Fed tends to treat involuntary part-time employment as a short-term problem, but the San Francisco Fed’s researchers debunked that idea last April in Involuntary Part-Time Work: Yes, It’s Here to Stay (emphasis original):

The U.S. unemployment rate has held steady at 4.1% in recent months (through March 2018). This is near historical lows, indicating a very tight labor market.

By contrast, the broader measure of labor market tightness called U6 has remained somewhat elevated compared with past lows. Why? The main reason is that U6 includes individuals who are employed part time but want a full-time job—the so-called “involuntary part-time” group, or IPT, labeled “part time for economic reasons” by the U.S. Bureau of Labor Statistics. Policymakers have flagged the extent of IPT work as one important indicator of the state of the labor market in the wake of the Great Recession (Yellen 2014)…

During early 2018, involuntary part-time work was running nearly a percentage point higher than its level the last time the unemployment rate was 4.1%, in August 2000. This represents about 1.4 million additional individuals who are stuck in part-time jobs. These numbers imply that the level of IPT work is about 40% higher than would normally be expected at this point in the economic expansion…

We find that the changing structural features of state labor markets have propped up IPT work in the aftermath of the Great Recession….

Changes in industry composition account for almost all of this slow shift toward increased IPT work. Rising employment in the leisure and hospitality sector and in the education and health-services sector, both of which have high rates of part-time employment, made especially large contributions to the overall change. We also found evidence that the amount of IPT work and informal “gig” economy jobs tend to move in tandem at the state level.

The shift toward service industries with uneven work schedules and the rising importance of the gig economy appear to be long-term trends that are unlikely to reverse in the near future. As such, in the absence of public policies aimed directly at altering work schedules, it looks like higher rates of involuntary part-time work are here to stay.

Now, of course, one can argue that the view that the unwanted level of part-time work is the result of “structural features” lets the central bank off the hook. But that is a tad simplistic. The power of Fed interest rate changes is not symmetrical. Businessmen do not expand just because borrowing goes on sale. They expand when they seem commercial opportunity. The only areas where dropping interest rates might lead a business to bulk up is if the cost of money is one of its biggest costs. That is most true for financial speculation. aka asset management. (In the US, because we have the peculiar institution of freely refinancable 30 year fixed-rate mortgages. lowering rates arguable leads to some stimulus via refinancings lowering housing costs and giving consumers more money to spend. But this is far less powerful that you would think. Bank fees eat up most of the benefit of reduced mortgage interest rates).

By contrast, increasing interest rates has a proportionally greater dampening effect. So the Fed can and does cause recessions, but it can’t do anywhere near as much to goose the real economy.

Nevertheless, the Fed has been champing at the bit to increase interest rates since the 2014 “tamper tantrum”. We’ve been told that quite a few people at the central bank had come to the view that QE and ZIRP were not stimulating the real economy and were creating distortions. And the Fed was particularly concerned that with rates as low as they’ve been, they have no room to drop them in the event of a financial crisis (without belaboring the apparent reasons, the Fed is visibly less keen about the idea of resorting to negative interest rates than the ECB. The prevalence of guns is no doubt a factor).

So the Fed has been looking for any plausible signs of sufficient vigor in the economy to allow the Fed to notch up interest rates without doing visible damage. Wolf Richter reads the latest tea leaves.

By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street

My fancy-schmancy Fed Hawk-o-Meter checks the minutes of the Fed meetings for signs that the Fed believes the economy is strong and that “accommodation” needs to be further removed by hiking rates, or that the economy is strong but not strong enough to raise rates further, or that the economy is spiraling down to where rates need to be cut. It quantifies and visualizes what the Fed wishes to communicate to the markets.

In the minutes of the January 29-30 meeting, released this afternoon, the mentions of “strong,” “strongly,” and “stronger” edged down for the fourth meeting in a row, this time by three points, to 22. The Hawk-o-Meter has now backed off quite a bit since the August 2018 high – when the Fed was rubbing it in that it would raise rates four times in the year – but it is still in outlier territory and redlining:

 

The average frequency of “strong,” “strongly,” and “stronger” between January 2013 and December 2017 was 8.7 times per meeting minutes. In the January meeting minutes, the 22 mentions were still 153% higher than that pre-redline average.

The average over the past 10 meetings minutes, starting with the December 2017 meeting, when the Hawk-o-Meter redlined inched down to 25.1 mentions.

Actually, “strong,” “strongly,” and “stronger” were mentioned 25 times in total, but as is not unusual, two were fake strongs, so to speak, and I removed them from the tally. But they’re interesting in their own right:

One referred the to strong-but-less-strong syndrome:

With regard to the postmeeting statement, members agreed to change the characterization of recent growth in economic activity from “strong” to “solid,” consistent with incoming information that suggested that the pace of expansion of the U.S. economy had moderated somewhat since late last year.

The other referred to the sudden hair-raising spike in repo rates at the end of 2018:

Repurchase agreement (repo) rates spiked at year-end, reportedly reflecting strong demands for financing from dealers associated with large Treasury auction net settlements on that day combined with a cutback in the supply of financing available from banks and others managing the size of their balance sheets over year-end for reporting purposes.

“Strong,” “strongly,” and “stronger” appeared in phrases like these:

• “Job gains have been strong, on average, in recent months….”
• “Household spending has continued to grow strongly….”
• “Total nonfarm payroll employment expanded strongly in December.”
• “Output gains were strong in the manufacturing and mining sectors….”
• “Real PCE growth was strong in October and November” [PCE = personal consumption expenditures or short, consumer spending].
• “Available indicators of transportation equipment spending in the fourth quarter were strong.”
• “Growth of C&I loans on banks’ balance sheets picked up in the fourth quarter, reflecting stronger originations….”
• “Issuance of both agency and non-agency CMBS [commercial mortgage backed securities] remained strong.”

But “moderated” also showed up:

• “Growth of business fixed investment had moderated from its rapid pace earlier last year.”
• “Global growth had moderated.”
• “The pace of expansion of the U.S. economy had moderated somewhat since late last year.”

And the brave new world of “patient.”

“Patient” was first and feebly introduced with one just mention in the minutes of the December meeting: “The Committee could afford to be patient about further policy firming.” This has now turned into a cacophony of “patient” with 13 mentions, including:

Early in the new year, market sentiment improved following communications by Federal Reserve officials emphasizing that the Committee could be “patient” in considering further adjustments to the stance of policy and that it would be flexible in managing the reduction of securities holdings in the SOMA.

Subsequent communications from FOMC participants were interpreted as suggesting that the FOMC would be patient in assessing the implications of recent economic and financial developments.

A patient approach would have the added benefit of giving policymakers an opportunity to judge the response of economic activity and inflation to the recent steps taken to normalize the stance of monetary policy.

A patient posture would allow time for a clearer picture of the international trade policy situation and the state of the global economy to emerge and, in particular, could allow policymakers to reach a firmer judgment about the extent and persistence of the economic slowdown in Europe and China.

But the minutes warned: Many participants observed that if uncertainty abated, the Committee would need to reassess the characterization of monetary policy as “patient” and might then use different statement language.

And “patient” might then be replaced with something like the predecessor phrase, “some further gradual increases in the target range for the federal funds rate.”

Meanwhile, as we’re biting out fingernails, waiting for the drama to unfold,… The Fed’s QE Unwind Reaches $434 Billion, Remains on “Autopilot”