US employment data for April was released last Friday. It was weaker than expected, with only 126,000 new jobs created during the month, and with the unemployment rate unchanged at 5.5%. To the 64,000 people of Bermuda, of course, 126,000 new jobs created in a month really would be something to write home about. But for the much larger US economy, it was seen as a disappointment, and just another nail in the coffin for anyone (like me) still harbouring any illusions about a first rise in short-term US interest rates as early as this June.
Will slower monthly data delay the Fed's lift-off?
I say "another nail in the coffin" because the March employment report wasn't the first sign of weakness in the US economy of late. Consider the monthly retail sales report, for example, where sales excluding autos have fallen in each of the past three months, or the monthly industrial production report, which has seen two falls in the past three months. Yes, things are slowing: from a strong Q4, maybe; from unseasonably poor weather in Q1, perhaps.
How confident do you need to be before tightening?
It did make me wonder, though: does the data ever make it easy when it comes to raising interest rates, given the obvious unpopularity of the move, and given the ever-present alternative of just waiting for next month's data "to be sure"? As someone who has been watching the monthly comings and goings of the US economy for twenty five years now, I know that there is a certain amount of 'noise' in the monthly data whatever the underlying economy is up to: expansions with the occasional fall in retails sales, recessions with the odd monthly increase in industrial production. In at least one way, business cycles are like true love: the course of them never does run true.
An experiment with the actual data
But suppose you were sitting around the Federal Open Market Committee (FOMC) table, with the eyes of the world focused on your every move. What would you want to see in the data before you would sign off on a lift-off in short-term interest rates? Well, here's a list to get things going:
- Did industrial production rise this past month?
- Did retail sales excluding autos rise this past month?
- Did housing starts rise this past month?
- Did durable goods orders excluding transport goods rise this past month?
- Did payroll employment rise by more than 200,000 this past month?
So, there are five conditions to be met. I chose a few of the so-called 'underlying' data series to avoid excess monthly volatility, such as with respect to retail sales and durable goods orders. The data I'm using is the data as it appears in the history books today (i.e. having been revised), not the data as it was originally released. Theoretically, it could make a few differences to the results in some months, but I doubt it would have changed very much the overall picture that we're about to see. Finally, let's say that - to raise interest rates - you would be looking for the above conditions to be met for three consecutive months, "just to be sure". So, would you have tightened policy already, given the above rules?
Be careful what you wish for in the monthly data: you may never get it
Well, no: you wouldn't have started tightening monetary policy since the Global Financial Crisis yet if these were your rules for doing so. Mind you, on these rules, you wouldn't have tightened policy, ever! That's right, ever. The above data has been available since March 1992, and there's been no consecutive three-month period since then in which industrial production, housing starts, retail sales ex autos and durable goods ex transport have risen, and where monthly employment growth was greater than 200,000. In other words, based on my criteria, policy makers would never have started the 1994-1995 tightening cycle, nor would they have ever started the 2004-2006 tightening cycle. In other words, there's always something in the high frequency data to worry about. Actually, in the 265 months for which all of the above data is available, there were only 26 months in which all of the criteria were met, and only two periods where they were met for two consecutive months. Following the first such period, in late-1993, the Fed did tighten. Following the second, in early 2014, it didn't, merely bringing its headlong balance sheet expansion to a close. Let's do one final thing with the data, which is to sum up the number of monthly instances in a consecutive twelve-month period in which all of the five criteria were met, which the chart below summarises.Set out this way, you can see that the data actually do a good of highlighting periods of Fed tightening. Actually, prior to the current recovery, the four instances in which the monthly indicators shouted "tighten" in the preceding twenty years coincided remarkably well with the four instances of actual policy tightening. On the face of it, it's just the last four years where the Fed funds target has been ignoring the monthly data. Is this time really so different to have warranted a four year hiatus in policy tightening? And if it did, by the way, should a couple of weaker monthly numbers in Q1 put off the day of reckoning another six months or more?
The real reason that the Fed will wait until H2 for lift-off
Actually, I too am coming to the view that Fed tightening is not now going to happen before July. But it doesn't have much to do with the weaker employment data in March, or the oil-price-induced slowdown in retail sales (just short of 10% of US retail sales are accounted for by spending in petrol/gas). You see, I was rummaging through my Fed archives late last week when I noticed the following sentence in the policy statements following the 12-13 September and 23-24 October 2012 meetings:
The Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.
I'm sorry I didn't notice this sentence earlier, because I'm not sure I would ever had thought the Fed would tighten in June if it had previously said it wouldn't, no matter how fleetingly. Because forward guidance is forward guidance at the end of the day - betray it once and you might never get a second chance. It will just have to be lift-off on 29 July instead.