U.S. Bond Market Week In Review: The Fed Turns More Dovish, Edition

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Includes: AFB, BAF, BBF, BBK, BFK, BKN, BLE, BSD, BYM, CXH, DMB, DMF, DSM, DTF, EGF, EIM, EIV, EOT, EVN, EXD, FMB, FMN, FTT, GOVT, IIM, IQI, KSM, KTF, LEO, MEN, MFL, MFM, MFT, MHD, MMU, MNP, MQT, MQY, MUA, MUB, MUE, MUH, MUS, MVF, MVT, MYD, MYF, MYI, MZF, NAD, NEA, NEV, NIM, NMI, NUV, NUW, NVG, NXP, NXQ, NXR, NZF, OIA, PLW, PMF, PML, PMM, PMO, PMX, PRB, PVI, PZA, RVNU, TAPR, TFI, VFL, VGM, VKI, VKQ, VMO, VTEB, XMPT
by: Hale Stewart

The Fed maintained their current policy, offering the following assessment of the economy in their announcement:

Information received since the Federal Open Market Committee met in January suggests that economic activity has been expanding at a moderate pace despite the global economic and financial developments of recent months. Household spending has been increasing at a moderate rate, and the housing sector has improved further; however, business fixed investment and net exports have been soft. A range of recent indicators, including strong job gains, points to additional strengthening of the labor market. Inflation picked up in recent months; however, it continued to run below the Committee's 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

Let's look at the data, as provided by the Richmond Fed:

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There were two sources of growth in 2015: PCEs and residential investment. In contrast, business investment and exports provided drags on growth. Overall, 2015 experienced two quarters of weak growth: .6% in the 1Q and 1% in the fourth. The US economy is grinding forward. But the sum total of all the weakness is starting to mount.

Regarding future developments, they noted:

The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen. However, global economic and financial developments continue to pose risks. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.

Once again, the Fed specifically mentioned international developments as a primary risk to the economy. Their concerns are justified as the World Bank recently argued:

A 1 percentage point decline in BRICS growth would lower growth in other emerging markets by 0.8 percentage point, in frontier markets by 1.5 percentage points, and in the global economy by 0.4 percentage point over the following two years. A continued BRICS growth slowdown - combined with financial market stress in emerging markets - could cut global growth by one-third in 2016.

Bloomberg described the situation this way:

The moves by ECB President Mario Draghi and BOJ Governor Haruhiko Kuroda "have gotten deep into the psyche of Fed officials," said Chris Rupkey, chief financial economist with Bank of Tokyo Mitsubishi UFJ Ltd. in New York. "The world's problems are not over yet, and until someone upgrades the growth forecast, the already reluctant Fed is unlikely to strike out very far on its own."

Since the first of the year, there's been a continued slight erosion around the global economic edges. No one has been able to provide a concise explanation about its causes. Instead, we've seen analysts use phrases like "weak demand" and "global linkages" to describe the phenomena. But it is most assuredly there, as expressed in the FT's global economic "nowcasts" and IMF's global outlook.

Bloomberg published an excellent piece explaining the split among the Fed governors regarding the inflation outlook. Titled, "Stanley Fischer and Lael Brainard Are Battling for Yellen's Soul," it offers a detailed look into the nuances of Fed policy and analysis. This week's inflation news bolstered the hawk's arguments. PPI was tame: overall inflation was 0% while total less food and energy was .9%. Both readings have been tame for the last 12 months:

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PPI, however, is rarely mentioned because most firms absorb cost vacillations into their cost structure. CPI was hotter with a core rate of 2.3% and total level of 1%:

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As this graph from the Cleveland Fed shows, core CPI and PCE rates are ticking up with both above the Fed's 2% target:

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As I showed last week, wages pressures are the primary reason for CPI's increase. And, given the weak pace of wage growth throughout this expansion, the Fed should let prices run a bit hotter before raising rates. Jared Bernstein offers supporting documentation here and here. Mark Thoma weighs in here.

Hale Stewart, XE.com