Hawkish Dove

by: Tim Duy

The generally dovish San Francisco Federal Reserve President John Williams sounded relatively hawkish in Wednesday's speech. The money quote:

I expect that continued asset purchases will be appropriate well into the second half of this year. In making this assessment, I don't have a specific unemployment or job-gain threshold in mind for cutting back or ending these purchases. Instead, I'm looking for convincing evidence of sustained, ongoing improvement in the labor market and economy. The latest economic news has been encouraging. But it will take more solid evidence to convince me that it's time to trim our asset purchases. An important rule in both forecasting and policymaking is not to overreact to what may turn out to be just a blip in the data. But, assuming my economic forecast holds true, I expect we will meet the test for substantial improvement in the outlook for the labor market by this summer. If that happens, we could start tapering our purchases then. If all goes as hoped, we could end the purchase program sometime late this year.

Based on William's current forecast, he expects the Fed will begin tapering off asset purchases this summer, perhaps the June FOMC meeting. He is apparently more optimistic than me, as this puts him at least three months ahead of my expectations. I had not anticipated slowing the pace of purchases until late in the year. Of course, the reality will be data dependent, with the next three employment reports being particularly important. As a recap, three of the last four reports have shown non-farm payroll growth at or above 200k:


Will Friday's March release make it four for five? Mixed signals from labor market indicators to date make it a tough call. While the downward trend in initial unemployment claims is generally supportive of a solid report, the numbers popped in the second and third weeks of March:


Could the recent increase be the first signs of fiscal contraction working through the economy, or just noise? We get another release Thursday. The employment number in the ISM manufacturing report was stronger, while the corresponding number from the nonmanufacturing counterpart was weaker. And the ADP release came in below expectations at a 158k gain in private sector jobs, suggesting a weaker report. Altogether, I would tend to expect a number on the low side of the current expectation of 192k gain, but don't see a lot to swing me dramatically away from that number - a number that is more consistent with William's story than not.

That said, I am cautious about extrapolating too much of the recent momentum forward. To be sure, the first quarter is shaping up to be better than the Fed anticipated, with Macroeconomic Advisors tracking forecast showing 3.6% growth. This could be giving Fed officials hope that this year's fiscal contraction is a nonevent. I am not yet convinced that we have dodged that bullet; rumor has it that sales-tax states had a weak March, possibly a delayed reaction to the end of the payroll tax credit. But more important is that the bond market is certainly not acting as if the economy is performing well enough to justify a shift in Fed policy. Notice that today the 10-year yield slumped to 1.81%, a low for the year. It seems as if bond market participants have become less confident of the recovery during the first quarter, even as Williams has become more confident.

Bottom Line: Williams placed a marker for the date that the Fed begins its exit from quantitative easing - summer, assuming that his current forecast holds. I am not so sure the bond market agrees with that assessment.