The Tone of Fedspeak Modulates

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Special Guest Blogger: Tim Kearney

The U.S. economy continues to chug along at a good clip. Inflation, output and expectations were all positive in the most recent readings. Key factors in the outlook remain trade discussions with the Chinese and the Federal Open Market Committee’s (FOMC’s) new reaction function, both of which are qualitative and difficult to assess ex-ante.

Given the calm inflation data, key Fed personnel have been taking steps to walk back their recent, more hawkish tone, suggesting that while the FOMC is likely to hike in December, it is not on autopilot to hike once per quarter in 2019. Chairman Jay Powell kicked off this idea, as he seemed to tack back to the “risk management” approach he outlined in August. Powell favors data-dependent risk management, so as not to pre-empt growth if inflation remains quiescent. His concern is the feedback from global growth back to the U.S. economy through trade and capital flow channels. Fed Vice Chair Richard Clarida continued this line, giving an interesting speech in which he called on the FOMC to be “especially data dependent” and expressing concern that the global economy is slowing. Importantly, he noted that policy is “close to neutral.”

After spiking in October, Fed Funds futures have scaled back down (appropriately, given quiet inflation). The December hike still appears likely, but even that has been knocked down to 67% probability from 75% one month ago. Right now, the markets appear to believe that two hikes in 2019 are likely. I believe we should prepare for at least three based on the likelihood of a U.S. economy surprising the consensus to the upside, which could halt the global slide in growth. On that front, the industrial sector shows more momentum. October capacity utilization outperformed expectations but at 78.4% is below the peaks in 2006 (81%) or 1999 (85%) or 1989 (85%). Industrial production rose by 4.1% YoY in October, continuing an unabated rise from the December 2015 -4% reading.

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