Much More To See

This week there’ll be much more to see
It starts with Jay’s testimony
Then data galore
Will tell us much more
From ISM to PCE

Today I’m going to start with a brief history of what has been the most important monthly data release during the past thirty-nine years. These are not hard and fast dates, merely approximations.

1979 – 1984: M2 Money supply was the key data point (it is actually released weekly) based on the fact that Fed Chair Paul Volcker was a pretty strict monetarist. This was before press conferences and the Fed never announced rates, they simply acted in the money markets to drive the Fed funds rate to their desired level. Remember, too, that this period was one where inflation was significantly higher and the Fed’s goal was to bring it down to a more reasonable level. However, there was no specific target like today.

1984 – 1988: The Trade Balance became the key data as the deficit grew significantly while the dollar approached record highs during this period. Volcker’s willingness to run tight monetary policy while the US was in the midst of expansive fiscal policy underpinned the dollar, and made US goods quite expensive globally. Remember, too that despite the equity market crash in 1987, the economy did not enter a recession.

1988 – 2017: For the past twenty years, the payroll report has clearly become the critical monthly release, starting with Alan Greenspan and running on through to Chair Yellen. This was during the ‘Great Moderation’ when central bankers thought that they had figured out how to defeat the business cycle. The employment data was seen as the key marker of economic activity, especially as the bulk of this time was before the Fed set a specific inflation target in 2012. For the period here before the financial crisis, the Fed was still far more concerned about inflation running too hot rather that too low, although the financial crisis certainly changed viewpoints there.

2017 – ?: At this point, I would argue that Core PCE has become the critical data point. While the argument over whether CPI or PCE is the better measure of inflation has been ongoing for a long time, the market reality is that PCE is what the Fed plugs into its models, so that is the one that should drive their decision-making function. Combined with the fact that the nation’s employment situation is now considered extremely robust, inflation is the variable that has the Fed’s attention. It is unclear how long this will remain the case, but I imagine it will be so for at least another year or two. After all, it’s not as though the Fed can change inflation’s course at the drop of a hat. So get used to the inflation story being the driver for now. And while PCE is the Fed’s preferred number, we get at least a half dozen different readings each month, any of which are likely to impact markets if they surprise, especially to the high side.

With that in mind, let’s look at what is happening in markets right now. If I had to characterize the dollar broadly I would say it is under pressure but there is very little consistency to the movement. Amid the G10 set, the pound has been the best performer after a speech from Labour leader Jeremy Corbyn highlighted his view that the UK should remain in a customs union with the EU upon Brexit. This view, which aligns with the portion of the Tory contingent that wanted to remain in the EU, may well moderate the outcome of the Brexit negotiations, and at least prevent the worst case of a ‘hard’ outcome. Combining this news with comments from BOE member Dave Ramsden who was previously considered a dove, that rates would be rising sooner than many expect, It should not be surprising that the pound has benefitted, rallying 0.5% this morning.

However, away from that news, there has been scant other commentary or data to drive things. For instance, while EUR and JPY are a bit firmer, CAD and MXN are both weaker. Commodity prices show strength in metals but not energy. Bond yields are little changed, although they have fallen from last week’s highs, and equity prices continue to march higher. In other words, there is certainly no broad theme to which markets are responding. I continue to look for tomorrow’s testimony by Chairman Powell as the first key for the week, but we do get a lot more data to ponder:

Today New Home Sales 600K
Tuesday Durable Goods -2.0%
  -ex Transport +0.4%
  Int’l Trade in Goods -$71.3B
  Wholesale Inventories 0.3%
  Case Shiller Home Prices 6.3%
  Consumer Confidence 126.0
  Powell House Testimony  
Wednesday Q4 GDP 2.5%
  Q4 Consumer Spending 3.7%
  Chicago PMI 65.0
Thursday Initial Claims 230K
  Personal Income 0.3%
  Personal Spending 0.2%
  Core PCE 0.3% (1.5% Y/Y)
  ISM Manufacturing 58.6
Friday Michigan Sentiment 99.5

Powell testifies to the Senate on Thursday as well, and we also hear from Bullard, Quarles and Dudley this week, but it beggars belief that the market will care about them with Powell so prominent. The data, however, should be critical, because we get the latest reading on Core PCE on Thursday. Given the recent inflation readings, where every one of them has been surprising to the high side, it doesn’t seem hard to believe that we see something higher here as well. My take is that the inflation story is evolving far more rapidly this time than it has in the past, and that econometric models are not coping well with the change. Don’t forget there will be a Prices Paid component to the ISM data as well, so there is plenty of opportunity for the recent price pressures to be made more evident this week. My gut tells me that we will continue to see inflation readings move higher and surprises will be in that direction.

In the end, I have a feeling that the question of whether the Fed is behind the curve is going to be asked more frequently as we go forward, maybe even at this week’s Humphrey-Hawkins testimony, and that the answer is a resounding yes. Powell’s style in this forum is a complete unknown, but he has been more forthright in his commentary style than any of the past three Fed chairs, so it is quite possible that the market gets a little shock tomorrow in the Q&A. But for today, I expect that market participants will remain quiet as they await tomorrow’s testimony.

Good luck