By Joseph Y. Calhoun
The stock market rallied hard into Janet Yellen's speech Friday at Jackson Hole, expecting some epiphany I suppose about the future course of monetary policy. What we got instead was Labor Market Dynamics And Monetary Policy, the purpose of which I can only suppose was to bore the market to death. Economics is not the most exciting subject in any case but Yellen plumbed new depths in soporific semantics with a speech focused on a view of inflation that I thought had gone out of style with leisure suits and disco. Apparently, Ms. Yellen has never heard of stagflation, that 1970s phenomenon that combines high inflation with high unemployment, something I thought banished forever the idea that inflation had anything to do with "labor market dynamics." Alas, I have erred for Ms. Yellen is a labor market economist and she is determined that her life's work not be wasted.
I guess I shouldn't be surprised. Ben Bernanke's specialty was the Great Depression and he spent his early years at the Fed convincing his fellow board members that the ghost of depressions past was stalking the economy in the form of the dreaded deflation. His influence on monetary policy and the Greenspan Fed's efforts to avoid repeating the mistakes of the 1930s led to, ironically, an episode of economic stress that resembled nothing so much as that depressing period. It is almost as if Bernanke created the very conditions for a repeat of the Great Depression just so he could show everyone he wouldn't make the same mistakes his predecessors made. And so we got entirely new mistakes the reckoning for which still await the markets and the economy.
Janet Yellen's tenure will apparently be spent concentrating on the labor market, her area of alleged expertise although tenured professor and government employee would not seem the ideal work history for such an "expert". That the labor market has almost nothing to do with inflation - and therefore monetary policy - is irrelevant to someone who has spent a lifetime studying it. Yellen is determined to make her work relevant whether we find it interesting or not. I just hope that she doesn't get a result like Bernanke's where her policies create the very thing she's trying to avoid.
Yellen admitted in her speech that "…historically, (labor market) slack has accounted for only a small portion of the fluctuations in inflation" and then promised "that many of the labor market issues you will be discussing at this conference will be at the center of FOMC discussions for some time to come." So, Yellen has placed at the center of monetary policy discussions a topic that even she admits is basically irrelevant. Well, that certainly gives me confidence about future policy.
Meanwhile, markets are putting out some interesting signals that if Yellen & Co. have time after their graduate seminar on labor market dynamics, they might want to take into account. First and foremost on the Fed's radar should be the recent activity in the market for the US dollar. The dollar index has been rising pretty steadily for some time now - although still not out of its range since 2008 - and the effect is being felt in other markets, primarily the one for government bonds. Bonds have been rallying all year contrary to all predictions and as I've pointed out before, that is due to falling growth expectations. Inflation expectations have barely budged all year - 2.2% at 10 years based on the spread between TIPS and nominal bonds - so a rally in bonds is a statement about future growth more than anything. I've seen so many explanations for the bond rally but it seems that no one can bring themselves to voice the Occam's Razor explanation - that despite recently improved economic data, growth expectations are falling.
Given the rise in the dollar and the fall in growth expectations per the bond market, it isn't surprising that commodity prices are falling too. The broad based indexes, such as the CRB, are still up on the year but peaked in mid-June as oil prices peaked. It is nothing short of amazing with all the geopolitical turmoil in the Middle East and Russia that oil prices have fallen almost 17% since peaking in the 3rd quarter last year. Part of the explanation for the slide is no doubt the rising dollar but one can't help but think about those growth expectations as well. Another part of the reason too is the growth of oil production in the US from fracking; the cure for high commodity prices is always high commodity prices. High prices lead to more production until supply once again exceeds demand and prices fall. All we know for sure is that supply right now exceeds demand; the reason for that development is indeterminate right now but is probably a bit of both.
If oil prices follow the lead of natural gas where a glut from fracking led to a precipitous decline in price, the Yellen Fed will not have to worry about inflation or labor market dynamics much less whether they are related. While lower oil prices might be good for the average American in the form of lower energy prices, the negative effect on the economy might offset any gains. The oil and gas industry has over the last few years accounted for nearly a third of capital spending and no small portion of overall economic growth. With high breakeven prices, it would not take much of a drop to turn off the gusher of capital flowing into oil well drilling and a significant source of GDP growth.
The stock market, like Janet Yellen, seems oblivious to what is going on the currency, bond and commodity markets. A rising dollar, falling growth expectations, falling commodity prices and falling bond yields are not the stuff of which inflation - and higher interest rates - is made. Neither are labor markets for that matter. Yellen seems to have been asleep the last couple of decades during the rise of globalization which more than anything affected the market for labor. It doesn't matter one bit for inflation whether there is slack or not in the US labor market. We are not an island. Last I checked, Europe and the rest of the world still had an ample supply of people able to fill any gaps in the US labor market. If Yellen and the FOMC waste their time studying the labor market while ignoring the deflationary signals coming from the market, next year's Jackson Hole meeting might prove quite a bit more exciting.