Hawkish Statements from a Fed Governor

Fed Official, Governor Michelle W. Bowman, gave a speech at Executive Officers Conference, Massachusetts Bankers Association, Harwich, Massachusetts on June 23. 

Key Points

• Inflation is the highest we have seen in the United States in 40 years and so far it shows little sign of moderating. At the same time, the economy is growing at a moderate pace, and the labor market is extremely tight.
• That tightness is contributing to inflation, because labor is the largest input cost for producing goods and providing services.
• Today, most people who want to work can find a job, and wages and salaries have risen faster than they have in decades. Even with these gains, wages have not kept pace with inflation, which has made it much more difficult for many workers to make ends meet in the face of soaring housing, energy, and food costs.
• The tightness of the labor market is exacerbated by a labor force participation rate that remains far below the pre-pandemic benchmark, representing millions of workers sitting on the sidelines.
• I expect that an additional rate increase of 75 basis points will be appropriate at our next meeting as well as increases of at least 50 basis points in the next few subsequent meetings, as long as the incoming data support them.
• The case for further rate hikes is made stronger by the current level of the "real" federal funds rate, which is the difference between the nominal rate and near-term inflation expectations.
• Since inflation is unacceptably high, it doesn't make sense to have the nominal federal funds rate below near-term inflation expectations. I am therefore committed to a policy that will bring the real federal funds rate back into positive territory.

Views

• The labor market is really tight. How tight? the 2 jobs are waiting for 1 worker kind of tight.
• The force participation rate is lower than the pre-[andemic level? Why don't people jusg get back to work?
• If inflactoin does not come down and the labor force keeps tight, Governor Bowman supports a 75 basis points hike and 50 basis points hikes in subsequent meetings. So a 75 basis points plus another 50 basis points is 125 basis points. Then the Fed funds rate would reach 2.75%-3%. The current 10 year treasury yield is 3.138%, which is close to the possible future Fed funds rate and bond prices have a lot to drop.
• The 10 year treasury rate remain relatively low with respect to the possible 3% Fed funds rates may be the resuts of 2 reasons. One, investors are betting not so many rate hikes described by Governor Bowman. Two, investors are fearful of recession so then people rather lock in with a 3.138 10 year yield even if the bond price would drop.

Immidiate to watch

• Oil Price Stabilization for signs of stablized inflation.
• Food Price Stabilization for signs of stablized inflation.
• Job creation and unemployment rate chane for signs of recession.

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Source: The Outlook for Inflation and Monetary Policy. Board of Governors of the Federal Reserve System. https://www.federalreserve.gov/newsevents/speech/bowman20220623a.htm. 2022/6/25

What was “Monetary Policy at a Crossroads” About?

On June 18, 2022, the Federal Reserve Bank of Dallas hosted a policy panel talking about monetary policy for both the Federal Reserve and the European Central Bank.

Key Points

Governor Christopher J. Waller

• That the Fed cut rate to 0% has only happened 2 times in histrory and there is good reason to think such a response may not be extraordinary anymore. Structural changes in the economy have tended to lower interest rates and limit the room that the Federal Reserve will have to cut rates during a slowdown.
• Financial markets stabilized relatively quickly. Over the course of 2020, the Fed's liquidity and credit facilities saw reduced demand and most of the emergency programs were decommissioned around year end.
• In September and December of 2020, the FOMC provided criteria or conditions in the meeting statement that would need to be met before the FOMC would consider raising interest rates and begin to reduce asset purchases.
• In November and December 2020, the unemployment rate was 6.7 percent.
• the Committee did not expect the economy to recover quickly.
• In 2019, unemployment was very low and inflation was near 2 percent, but the policy rate was well above zero and close to its neutral value. It should not have been a surprise that the policy rate would rise fast in 2022.
• 2% for inflation is not a ceiling but a target.
• Market can price in Fed's forward guidance immidiately.
• There are 2 jobs for every unemployeed worker. The labor market is tight. The fear of recession is overblown,

Olli Rehn, Bank of Finland Governor and ECB Governing Council

• Europe's economy revoered from the COVID cries faster than expected.
• Energy inflation is the main driver for eurozone inflation.
• Europe's umemployment is at 40 year low of 6.8%.
• ECB is targeting at 2% inflation rate in the medium term.

Donald Kohn, Robert V. Roosa Chair in International Economics; Senior Fellow - Economic Studies, Brookings Institution

• Prices rose becasue of supply did not keep up with srtong demand.
• Stresstests on Fed's policys against unusual outcomes could be helpful.
• On the supply side, we could increase ligal immigration and lower tarrifs.

Views

• The economy recovered faster than expected. The unemployment rate improved faster than expected. Both have mad Fed hike rate faster.
• The demand for labor is high, so steep rate hikes may not induce too much unemployment or recession.
• Energy prices play a big role in inflation. If enertgy prices stable, inflation could be, too.
• Europe's unployment is at 6.8% and their raising rates? Does this mean it is more likely that Europe would go into recession?
• It is a good thing that Fed gives their forwad guidance and the market can price it in quickly. Because this mean the current stock and bonds' prices are alreafy relfected to the target Fed funds rates.
• The market can price in Fed's forward guidance, and the recent maket drop, I thnkg ,was spooked by the dramatic increase of forward guiadnce. Therefore, although forward guidance helps investors prepare for future market conditions, the forward guidace can change.
• The stock market can bottom if inflation is gradually controlled while the labor market did not get hurt too much. Waiting for FOMC meeting is too late to price in maket. For indivisual investors, even the inflation and labor market data is too late. The market would just pirce them in immediatiely. By the way, we would see some rebounds if the next CPI data is not so bad or otherwise could happen. 
• Jul. 13, 2022 is the date for releasing the next CPI data.
• Let's see if old prices can stablize. If it does, will inflation do, too?

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Surece: Panel Discussion: Monetary Policy at a Crossroads. Board of Governors of the Federal Reserve System. https://www.dallasfed.org/research/events/2022/22panel. 2022/6/18

Fed Rate Projections Analysis June 15, 2022

This article is about analysis of market conditions from Fed's data.

2022/6/15

• The projected medium rate for 2022 is 3.4% which is 1.5% higher than the March projection. This is a big increase. One thing to keeping watch is whether the projection grows at the next meeting.
• The projected medium rate for 2022 is 3.4%, but the Fed funds rate now is just about 0.75%, which is 2.65%. 2022 is hafl way over. If inflation does not come down, we migh see bigger increase in rates in the coming meetings.
• 3-year bond yield is at 3.33%, 10 year is at 32.5% and the 30 year is at 3.35. The yield curve is realy flat, which is dangerous. We should continue to watch is yeild cuve is inverted.
• Projections for GDPs drop from the March meeting. 
• Umemployment rates increase from the March meeting.
• We should pay close attention to demands, because umemployemnt is set to increase. I expect demands will hurt during the course of combating inflation. It is just how much demand will drop so that recession is not triggered.
• Overall, it is still a good thing that Fed can raise rates to combat inflation, because US economy is resilient. 

Bond Downside Risks

The 10-year yield is at 3.25%, If rate rise instantly 2.65%, US 10-year treasury price will drop 20.06%.

The 30-year yield is at 3.35%, If rate rise instantly 2.65%, US 30-year treasury price will drop 37.67%.

The Stock Market Spooked by High CPI Data

Today the US stock market suffered. I am not here to restate how much the Dow, S&P 500 or NASDAQ dropped. But I would like to share one point.

Why Stock market dropped?

My theory is that the stock market suffered today, because people think the Fed would hikes rates faster and they want to wait for better bond yields. Also, according to many for the stock valuation techniques, while profits stay the same, stock prices should drop. Some of the stock valuation techniques includr dividend discount model or simply by comparing the company's inverse PE ratio to 10-year treasury yield.

So, it's fine

If the whole stock market retesting 3,900 points for S&P 500 is just a stock price valuation problem. The long term return of stock market should still be OK, especially US Dollar index today grew almost 1% and reached 104.19, which is another sign the stock market priced in strong Dollar.

We need to worry if Dollar drops with the stock market.

Yield Curve

Finally, the protagonist today is yield, which is affected by the Fed's rate hikes decision, which is affected by today's CPI data. 

But, wait a minute, if the Fed is going to raise the Fed funds rate, which is overnight, really short, greatly, would the short-term yield rises passed the long-term ones? Especially when investors are worried about huge maket downturns, when they would rather buy long-term bonds to lock in returns and push bond prices higher, long-term rates lower.

The above did not happen today. I guess investors are keeping their cash and just waiting for another stock or bond buy in opportunities. 

By the way, not only can you wait for stocks to drop more and buy, you can also wait for yields to get higher and buy bonds.

Continue to watch

• Does yield curve invert?
• Fed's rate hikes decision
• US Dollar index

Why Follow the Fed?

The Fed has 2 goals set by Congress. They are maximum employment and stable prices.

If achieved, US economy should be in good conditions where Dollar could remain strong and buying power of average American should continue to grow. 

Why Inflation is Good?

When economy grows, more money needs to be supplied into the market so prices make sense.

Imagine a world where are only 2 one-dollar bills and there are only 2 people living in this wolrd. Each has a dollar.  One person grows wheat, the other raises pigs. 

One day they want to trade. The farmer wants to trade the one dollar for a pig with the other person who in the other hand wants to trade for a bag of wheat. The deal is done. Each still has 1 dollar.

But, both the wheat farmer and the pig farmer continues to grow produce wheat and pigs respectively.

With more products in the market, the original prices of pigs and bags of wheat start to make no sense. How do you price a pig when there are only 2 one-dollar bills in the world while there are a lot of products due to economic growth?

More money is needed so that a pic can remain 1 dollar, so does a bag of wheat.

Back to inflation

Now, there comes the third person so makes smart phones. Both farmers would like to trade for 1 smart phone many of their products, either wheat or pigs.

The smart phone producers think it iOS so easy to make money that he could pay 2 dollars for a pig. 

Inflation happens due to economic growth, when both farmers' product have not changed but their prices have.

Why is it good again?

Inflation triggered by economic growth is normal. Then we should be happy watching one of the Fed's goals, long term inflation of 2%, achieved.

Maximum Employment

When unemployment rates are low, prices should grow, because almost everyone has a job and contribute to the economic growth.

The maximum employment here is the same as both farmers in the previous example have wheat to grow and pigs to raise. If most people work to produce products or provide services. Economic should grow.

Stable prices

When most people are working, what we want to watch next is whether if they are spending. This is the demand side of the force that pushes economy to grow.

Back to the famers' example. When the smart phone maker comes into the world, what would happen of the farmers do not demand any smart phone? They don't buy any.

The smart phones would worth nothing and the smart phone maker would starve to death.

On the other hand, if the farmers would like to buy new phones, they would trade their wheat or pigs for one. In modern day language, they would spend money on smart phones.

What about stable prices?

When people are creating products or services and willing to spend their money, both economic driven forced of supply and demand would bring in the world of better or more products or services. Then more money is needed so that the better products can be priced higher.

If inflation is too high, which is triggered strong economic growth, the Fed could raise interest rates or sell bonds to reduce money supply. 

Consider the previous example of farmers, if the world continued to have only 2 one-dollar bills, the 2 one-dollat can be used to buy more wheat or pigs, right? Because products increase while money supply does not.

Therefore, when the economy is healthy and money supply is reduced, currency value would increase, in other word, US Dollar will grow.

The Fed's Dual Mandates Achieved

This is why watching the Fed's decision on rates or other related things is one important way to assess the health of US economy.

If both maximum employment and stable prices are achieved, this could mean strong Dollar and strong stock market.