The Fed’s task
As we all know, the Federal Reserve is trying to balance unemployment and inflation – the proper function of monetary policy anyway. The target is full employment, consistent with an inflation rate of about 2%.
So, to look at what any change in Fed policy might be, we need to look at unemployment and inflation. Currently, the employment situation isn’t a problem – we’re at the lowest unemployment rates in half a century.
This usually being when the Fed raises interest rates in order to head off inflation. So, we want to see what inflation there may or may not be.
We can also approach this another way, which is that the Fed itself has been quite clear that they’re not going to cut rates unless the current growth rate wilts significantly. The current around and about 2% GDP growth is what we all think is the potential for the US economy. We don’t expect a build-up of inflationary pressures at this rate that is – but we should check to make sure.
As far as we can see, there is no awakening of inflation – thus, there will be no change in Fed policy nor interest rates.
Consumer Price Index
The more general commentary here is that inflation is strong enough that we’d not be looking to a rate cut as the Fed’s next move. In fact, the tight labor market is causing reasonable wage inflation which, given the low general inflation rate, is increasing real wages. Good, that’s what we want to be happening anyway, real wage rises. However, this does mean that the risk is to the upside.
Current forecasts are for no rate change in 2020 – on the current information, I’d agree. But if there is to be a rate change, I’d say upwards from this information.
The Beige Book
We’ve also another information source here, the Beige Book. This is really a series of stories – conversations if you like – from varied Reserve Banks around the country. What is it that people are actually saying? As such, there’s no attempt to calculate anything, we don’t get any statistics or numbers here.
However, the general story coming through is that growth is reasonable and consistent but that the labor market is indeed tight. Precisely because nothing is enumerated in this source we can’t say by how much and all that, but we do get the impression of what it is that people are thinking and worrying about – precisely the intention of the Beige Book itself.
The next thing to worry about might well be that wage-led inflation. The cure for which is a rise in interest rates, of course.
The Investor View
The consensus view is that there’s not going to be an interest rate change before the summer. I concur with that. That’s also the useful bedrock to our view of these next few months. After that, well, predictions about the future and all that. But we should be thinking that the next interest rate change is going to be up, not down. This means that bonds are about as valuable as they’re going to get. It becomes a bear market from here on in for them.