Morning Report: Why the Fed keeps missing on inflation 4/12/18

Vital Statistics:

Last Change
S&P futures 2355.5 14.5
Eurostoxx index 377.42 1.23
Oil (WTI) 66.58 -0.24
10 Year Government Bond Yield 2.80%
30 Year fixed rate mortgage 4.39%

Stocks are rising this morning on no real news. Bonds and MBS are down.

While investors are still worried about conflict in Syria, things seem to be settling down somewhat as Russia seemed to cool their rhetoric and Trump backed off from suggesting an attack was imminent. Call it WWE diplomacy: lots of trash-talking outside the ring, which often leads nowhere.

The last of the 3 inflation indicators this week came in lower than expected. Import prices were flat month-over-month and rose 3.6% YOY. Import prices are driven by the currency and commodity prices, so the Fed tends to de-emphasize them.

Initial Jobless Claims fell to 233,000 last week. The labor market continues to shrug off the volatility in the markets.

The FOMC minutes didn’t really reveal much we don’t already know, however one statement stuck out. On the labor market, they mentioned that the labor force participation rate was stronger than they had expected. That is interesting because the conventional wisdom in the markets and Washington is that the labor force participation rate is too low. The implications of that view – that the labor force participation rate should be lower – means that their inflation forecasts going forward might be too high. They are forecasting the unemployment rate to fall lower, which would in theory trigger more wage inflation (companies fighting for fewer workers), and push the Fed to hike rates faster in response. If they are getting the forecasts wrong for the labor force participation rate, it means that (a) they have more room to let the economy run, and (b) the longer-term growth rate of the economy is higher. This is good news. Perhaps it is a realization that fewer people are retiring at 65, and many of those longer-term unemployed are returning to the labor force. The labor force participation rate acts as sort of a speed limit for the economy. As it rises, the speed limit rises as well.

With regard to trade, this is what they had to say: “Participants did not see the steel and aluminum tariffs, by themselves, as likely to have a significant effect on the national economic outlook, but a strong majority of participants viewed the prospect of retaliatory trade actions by other countries, as well as other issues and uncertainties associated with trade policies, as downside risks for the U.S. economy.” In other words, the trade war has to really escalate for it to register economically.

Mick Mulvaney laid out his vision for the CFPB in his semiannual testimony to Congress yesterday. His prepared remarks are here. As he alluded to earlier, things are changing: “The Bureau is going about its work in several new ways. First, to execute the new mission, the Bureau will continue to seek the counsel of others and make decisions only after weighing relevant available evidence and a full range of perspectives. Second, the Bureau will protect the legal rights of all, equally. And third, we will do what is right with confidence, acting with humility and moderation.” On enforcement, he said: In another change, the Bureau practice of “regulation by enforcement” has ceased. The Bureau will continue to enforce the law. That is our job, and we take it seriously. However, people will know what the rules are before the Bureau accuses them of breaking those rules. Finally, he stated that the CFPB will review the Home Mortgage Disclosure Act and recommend changes.

CoreLogic notes that we have yet to see any effects of the new tax regime on home price appreciation. It is still early, however. That said, we do have a lot of inventory at the higher price points – probably most of it was driven by building decisions over the past several years – however tax reform is certainly not helping, at least in the high price / high tax MSAs.

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