U.S. Bond Market Week In Review: Rosengren Gets It Right, Edition

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Includes: AGG, BHK, BND, BNDS, BOND, BTZ, DBL, FBND, GBF, HTR, ICB, IUSB, JHI, JMM, PAI, PCM, PTY, RCS, RINF, SAGG, SCHZ, TAI, UBND, VBF, VBND
by: Hale Stewart

Federal Reserve presidents take two approaches when discussing the economy. The most common one only mentions employment and inflation, followed by a discussion relating both to the Fed's dual mandate. There is nothing inherently wrong with this approach. It benefits from being simple, while also demonstrating that the president making the presentation is considering economic events relative to the Fed's dual mandate. But simplicity is also its primary drawback. The US economy is a complex entity; only referring to two statistics does not provide adequate depth to meaningfully explain a president's analysis.

A second group of presidents (Brainard, Evans and Rosengren) offers far more nuanced analysis in their speeches. Boston President Rosengren spoke earlier this week. Like most presidents, he begins by mentioning labor markets have improved and inflation remains contained:

Turning to the national economy, in December the FOMC raised short-term rates for the first time since the financial crisis, by a quarter of a point. That decision reflected further improvement in a range of recent labor market indicators, confirming that underutilization of labor resources has diminished - and the Committee's expectation that inflation will return to 2 percent, the inflation target set by the Federal Reserve, over the medium term.

But he then notes:

While labor markets have continued to improve gradually, headwinds generated from abroad have created more volatile financial markets and concerns that U.S. domestic growth may be impeded by these headwinds and inflation may not move as quickly to the inflation target.

Fed presidents who focus exclusively on domestic demand assume the US economy can generate sufficient domestic growth to be self-sustaining. And at $17.4 trillion, they have a solid point. But foreign developments have risen in importance and impact as economies have become more interconnected. This is a key point addressed in Rosengren's speech.

He first offers the following chart of global equity markets:

While no stock market is representative of an entire economy, they are excellent barometers of sentiment. And when four major global equity averages drop in unison, it's obvious global opinions are declining. He next references global inflation levels:

While we tend to focus on our own weaker CPI numbers, it's important to remember that low inflation is a global phenomenon. By highlighting the global nature of weak price pressures, Rosengren implies that, at least partially, we're importing deflationary pressures. He bolsters this claim with the following two charts:

The top chart - which shows the trade-weighted dollar - has risen substantially since mid-2014. This, in turn, has depressed commodity prices, shown in the second chart. While market mavens have focused nearly exclusively on weak oil prices, Rosengren shows the entire commodity complex has suffered from a combination of oversupply and weaker demand.

He then concludes with the following summation:

Since the December publication of the Summary of Economic Projections, we have seen oil prices decline and global stock indices become more volatile - and more generally a lack of inflationary pressures and the presence of global headwinds that make future economic growth somewhat more uncertain. Should these conditions persist, and slow progress on attaining the Fed's dual mandate, I believe the normalization of monetary policy should be unhurried, and wait for economic data to improve.

Rosengren packs a great deal into one emboldened sentenced.

  1. Commodities (raw material inputs) continue to decline.
    1. This indicates a supply/demand imbalance exists at the factory input level.
  2. Global stocks continue to decline
    1. Global sentiment is weaker, indicating that across the developed world, GDP projections are declining,
  3. Inflation pressures are weak.
    1. Demand growth is weak at the consumer level.

Put more broadly, there are three key macro-level data points indicating weaker growth ahead. An analysis focused exclusively on the US domestic economy would have missed the breadth of the potential problems, which is why Rosengren's analysis is so compelling.

Hale Stewart, XE.com