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Fed bides its time as inflation remains below target

In a recent report to both the U.S. Senate and the House of Representatives, Federal Reserve Chair Janet Yellen gave a detailed view of the U.S. economy and monetary policy actions.  She referred to the labor market as “close to full employment,” with the unemployment level at 4.8 percent and an average of 200,000 jobs a month being created since June 2016.  While the labor force participation rate has not risen to pre-recession levels, she viewed the mostly sideways movement as acceptable, given demographic changes (ie., aging population) in the workforce. 

Yellen reiterated that the measure of inflation most important to the Fed is the personal consumption expenditure index, or PCE, which rose 1.7 percent in the last 12 months, thus remaining below the FOMC target. She went on to state that surveys of inflation expectations were “stable,” and market-based measures of compensation were at low levels.  She saw no short-term inflationary problems, since recent increases in energy costs were expected. 

On the gross domestic product, Yellen spoke of the slow gain in GDP in the first half of 2016, around 1 percent, and the improvement to two and three-quarters percent in the second half of 2016.  Strengths in the economy were mostly consumer based. With the household debt ratio near all-time lows and the household net worth to income ratio near an all-time high, Yellen saw consumer spending continuing to rise at a healthy pace, and the economy continuing to grow moderately. 

However, she did mention continuing challenges. The current economic expansion has had the slowest rate of GDP growth in any postwar recovery.  She cited both the slowly growing labor force and productivity in our economy as impediments to growth.  Add in the global nature of the recession and the resultant strong dollar, and our GDP growth has received no help from exports.  Yellen did suggest a recent upturn in business spending might be beginning, as consumer spending and the labor force continue to strengthen.

As for monetary policy, Yellen’s message remained unchanged.  Citing slow global growth, weak U.S. productivity and strong demand for safe long-term assets as reasons that the neutral federal funds rate was low, she foresaw only slow, moderate increases in the federal funds rate. 

The boilerplate of Fed policy going forward remained: “In determining the timing and size of future adjustments to the target range for the federal funds rate, the committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.  This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations and readings on financial and international developments.” 

 Yellen again suggested that the Fed would not offer specific opinions on fiscal policy but “would point to the importance of improving the pace of longer run economic growth and raising American living standards with policies aimed at improving productivity,” and “it is important to remember that fiscal policy is only one of the many factors that can influence the economic outlook and the appropriate course of monetary actions.” 

 Look for an increase in the federal funds rate no sooner than June, and watch the Fed try to remain outside the political scope of Washington. 

Recent data releases highlight the Fed’s views.  Inflation as measured by the producer price index, or PPI, jumped 0.6 percent in January, the biggest increase in over four years.  The “core” rate, which precludes food, energy, and trade, rose 0.2 percent for the month.  As expected, energy costs shot up 4.7 percent, while trade (0.9 percent) and transportation (1.1 percent) added to the wholesale price escalation.  However, the one-year increases for both headline and core PPI were 1.6 percent—not terribly worrisome, although well advanced from year ago levels. There were also noticeable price increases at the intermediate levels of PPI.  Processed goods rose 3.8 percent for the year, while falling 5.3 percent in the prior year (all energy related), and unprocessed goods had similar disparities, again energy related.  The consumer price index rose 0.6 percent in January as the “core” rose 0.3 percent. All energy costs were 4 percent higher than December 2016, while gasoline jumped 7.8 percent in one month.  For the 12 month period, all consumer prices rose 2.5 percent and “core” prices were up 2.3 percent, with gasoline up a hefty 20.3 percent. 

 Two thoughts here: first, gasoline prices were coming up from unnatural lows, thus the larger percentages. The general thinking is that prices will now level, or decline a bit, blunting any further big bumps.  Second, the Fed watches these indicators but favors the PCE. 

Those hoping for a strong year of consumerism got a nice message from retail sales, which rose a steady 0.4 percent in January and were up 5.6 percent year-over-year.  Add in a revision upward in December, which should aid fourth quarter GDP, and consumers seemed to be back in a better frame of mind. Auto sales had a poor month, down 1.4 percent, or the total sales number would have been much better. There were some blips in the data. Internet sales reported no gains over December (big holiday spending, then a break?), gasoline sales rose 2.2 percent (price driven), restaurant sales increased 1.4 percent, and general merchandise stores sales rose 0.9 percent (after-holiday sales?). All in all, a pretty good start for 2017.

Stock prices are 5 to 8 percent higher after the first two months of 2017 as euphoria over pro-business fiscal policy continues.  

Gregory McKay is economic consultant to Canandaigua National Bank.

3/3/2017 (c) 2017 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email rbj@rbj.net.



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