The Sept. 20-21 meeting of the Federal Open Market Committee yielded a bit more insight into Federal Reserve Bank thinking, as quarterly projections of data were offered and a press conference by Chair Janet Yellen addressed many issues. The federal funds rate remained unchanged at 0.5 percent and during the press conference, Yellen offered the following observations and answers to questions:
Economic picture. Economic growth appeared to pick up as the second half of the year got started. Consumer spending was solid, business spending was weak. Job growth was solid, but the unemployment rate and job participation rate were little changed during the year. Overall inflation was low due to energy, import prices and the global economy. Core inflation has been running slightly higher.
Federal funds rate change. Yellen said the FOMC was close to goals on the unemployment rate and the underlying inflation rate, and said much of the meeting discussion was about the timing of the increase. Most of the committee members felt the case for a rate increase had strengthened but wanted to wait for more progress toward their objectives.
Federal funds rate level. Some analysts believe the rate is too low. Yellen explained that the current rate is below the neutral nominal federal funds rate (the rate that is neither expansionary nor contractionary to the economy). This neutral rate is historically low due to expectations of 2 percent or less GDP growth, and indicates belief by the committee that some economic stimulation is still needed.
Productivity. GDP growth is projected to be lower than historical levels because of problems with our productivity. We’ve had good job growth since the Great Recession, but very poor output growth (more workers producing less goods and services). A combination of mismatched job skills and inexpensive imports will hold productivity down (and slow GDP growth) for some time to come.
Inflation. What ultimately causes inflation is a tight labor market and higher resource utilization, according to Yellen. We have the job growth, but low productivity has put no pressure on resources. In earlier decades, expanding jobs begat inflation (the Phillips Curve). That inverse relationship appears broken. Personal consumption expenditure inflation is not expected to top 2 percent in the coming years, while unemployment remains below 5 percent.
Economic bubbles. In answer to some concerns about the possible development of economic bubbles, Yellen said asset overvaluation worries were moderate at the present time, but did suggest the commercial real estate market might “have some issues developing,” which the Fed would monitor.
Weak business spending. Yellen acknowledged a poor business investment climate, putting part of the blame on the massive contraction in the energy sector. However, she said general weakness in the rest of the business sector was hard to understand, as consumer spending and sentiment remained solid.
Politics. Lest we forget the election, the question of political influence on Fed decision making was asked four times. Yellen emphatically answered each time that politics are not discussed at meetings, nor does the committee take politics into account during their discussions. Period.
Economic risks. Yellen said the FOMC believed that current risks to the labor market and inflation were “roughly” balanced, but went on to say the committee is “struggling” to understand the magnitude and nature of the employment and inflation risks. The balance of these risks is more serious and “can offset one’s judgment about the appropriate timing” of rate changes.
The committee seems on target with its comments on business and inflation, but seems a bit optimistic about consumerism. July and August retail sales showed consumers were somewhat cautious in their spending habits. August 2016 sales were a mere 1.9 percent higher than August 2015 levels. August 2016 levels were down in almost all categories with the exception of grocery sales and restaurant sales. Personal income and expense data provided by the Commerce Department for August concurred. Inflation adjusted disposable income rose a modest 0.2 percent, while inflation adjusted personal expense fell 0.1 percent.
Housing data were also mixed. Single family housing permits continued to shrink, and single family starts in August were only 0.9 percent higher than year ago levels. August existing home sales were 0.9 percent below July 2016 levels and up only 0.8 percent from August 2015. Inventory remains tight, increasing the median price to $240,200, up 5.1 percent from year ago levels. New home sales fell 7.6 percent from July 2016 levels, but were 20.6 percent above August 2015. The median price continues to shrink as developers concentrate on the $200,000 to $299,000 area.
Business data remain constrained. Industrial production and capacity utilization both fell in August, as ongoing slowness in manufacturing and utilities offset some slight improvement in mining. Durable goods orders also slowed in August, and are 0.6 percent below year ago levels.
Inflation data for August remains muted. The producer price index for final demand was flat in both August and for the past 12 months. Core PPI rose 0.3 percent in August, and was up 1.2 percent for the past year. The consumer price index rose 0.2 percent in August, and was up 1.1 percent for the past year. Core CPI was up 0.3 percent in August and 2.3 percent in the past 12 months (service costs for medical, shelter and transportation were all running up 3+ percent).
OPEC just rolled out a trial balloon that suggested a cut in production of around 2 percent was being considered. Predictably, oil futures are hopping around and stock markets are trying to focus. Toss in the U.S. elections and the almost shutdown of the federal government, and there’s plenty to consider in the coming weeks.
Gregory MacKay is economic consultant to Canandaigua National Bank.
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