Monday 20 March 2017

Fed confirms intention to stay behind the wage-inflation curve

Wages growing 3-3.5% by year end? Or will they accelerate as U6 struggles to go under 9% and Trump implements various policies? The benefit of a strong USD, flat/ negative prices paid and falling commod prices are also in reverse or flat now.

Fed is about 0.5% behind the curve by their own standards, given Libor is higher than Fed funds. However projecting forwards 12 months if U6 drops to say 9%, the Fed funds were at 3% last time... 

Last time however the Fed was not pursuing an overt policy of financial repression and debt was not growing 3x faster than nominal GDP. But this time next year, who knows who will be Fed chair or what the central policy goal will be - although I'm sure Steve Bannon has a few thoughts on the matter.


The Fed's rate forecasts are based on the following assumptions:
  • Full employment this year
  • PCE stabilising at 2%
  • GDP growth stabilising at 1.8%

So they are assuming that jobs will be created and economic growth delivered but there will be no knock on impact on inflation or wages? Seems unlikely. PCE is 1.7% and on a generally rising trend. 

If PCE goes to 2.5% and the Fed is still below 1.5%, ie this year, and that rise in PCE is underpinned by wages, then the Fed will be in a bind. They wont want to hike rates as it risks a recession, but they will be in breach of their inflation mandate. 

In my view the next Fed chair will be politically appointed and will be expected to let wages run, which again underpins a wage-inflation cycle. In otherwords, despite the Fed gradually hiking rates, real rates become even more negative now. In fact Yellen even argued the case that -2% real was now 'neutral' in last weeks press conference. 

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