What will the US Federal Reserve do next?

One of the regular themes of this blog has been uncertainty about the state of the US economy post credit crunch. We have many metrics which record an improvement and yet this recovery somehow seems to be not quite like ones in the past. This is perhaps best highlighted by the data from the labor ( as they spell it) market. If we look at the headline then the situation if we use old style thinking looks rather good.

Total nonfarm payroll employment rose by 255,000 in July, and the unemployment rate was
unchanged at 4.9 percent, the U.S. Bureau of Labor Statistics reported today.

So as we approach concepts of the natural rate of unemployment and what some considered to be full employment we see that the US economy is still creating jobs. However Ivory Tower economic models would have forecast a lot more than this.

Over the year, average hourly earnings have risen by 2.6 percent.

In yet another twist they would not be predicting that real wages would be rising nor that consumer inflation would see a dip.

The all items index rose 0.8 percent for the 12 months ending July, a smaller increase than the 1.0 percent rise for the 12 months ending June.

But perhaps the biggest challenge for those in their Ivory Towers has been this.

Both the labor force participation rate, at 62.8 percent, and the employment-population ratio, at 59.7 percent, changed little in July.

The labor force participation rate was more like 66% to 67% before the credit crunch  and this matters as falls in it flatter the unemployment numbers.In round number terms we would expect the US labor force to be around 168 million rather than the current 159 million for the level of population. There are demographic issues like an increased number of retirements as the baby boomer generation age but it is also likely that some have become what is called “discouraged”.

Open Mouth Operations

We have seen plenty of these from the US Federal Reserve in 2016 and the opening salvo came from John Williams of the San Francisco Fed on January 4th. From Reuters.

For 2016, “I think something in that three to five rate hike range makes sense at least at this time,” Williams said in an interview on CNBC.

Since then he has suggested 2-3 and 2 and as I wrote on the 16th of this month now seems to be more of fan of higher inflation targets than higher interest-rates. So a bad 2016 for his credibility, especially as we note the number of interest-rate increase so far which is 0 and the approaching US election.

Yesterday the baton was picked up by Vice-Chair Stanley Fischer.

So we are close to our targets. Not only that, the behavior of employment has been remarkably resilient.

Let us look at the thinking behind it and as ever it focuses on the labor market.

Employment has increased impressively over the past six years since its low point in early 2010, and the unemployment rate has hovered near 5 percent since August of last year, close to most estimates of the full-employment rate of unemployment.

You may note that Stan still seems to think that concepts such as full employment are at play although even he cannot avoid mentioning this.

depending on what happens to labor force participation among other things.

The “missing” 9 million only get a sideways mention.

reflecting demographic factors such as the aging of the baby-boom generation

Actually in Stan’s world all the old Ivory Tower concepts seems to be at play.

the unemployment rate is currently close to most estimates of the natural rate

Indeed he follows John Williams by still apparently believing there is a natural rate of interest as well.

The decline in estimates of r*–the neutral interest rate that neither boosts nor slows the economy–which is related to the fear that we are facing a prolonged period of secular stagnation.

In a rather extraordinary addition footnote 10 adds this to our sum of knowledge.

For the record, I note (a) that looking ahead, I expect GDP growth to pick up in coming quarters, as investment recovers from a surprisingly weak patch and the drag from past dollar appreciation diminishes, and (b) that I am an optimist.

It is hard not to wonder if like the US Federal Reserve back then Stan was an optimist heading into the 2008 recession? But if we look at part a) then it looks for now as if he is getting some support from the data.

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2016 is 3.6 percent on August 16, up from 3.5 percent on August 12. ( Atlanta Fed )

Accordingly Stan may think job done in terms of Open Mouth Operations as he reads this in the Financial Times.

The Federal Reserve is close to meeting both its targets for the US economy, one of its leading policymakers said, as he delivered an upbeat verdict on the post-crisis recovery.


Even a cursory look at the rhetoric on inflation provided by our Stan poses problems.

Although total PCE inflation was less than 1 percent over the 12 months ending in June,

Like Adam Posen used to do when he was at the Bank of England Stan has to pick and chose amongst sub-indices to claim we are close to target. Rather oddly he does not seem to simply point out that he thinks inflation will pick-up going forwards. After all he is supposed to be looking 18/24 months forwards.


There is a problem here for Stan as his employment cheerleading meets the output or GDP (Gross Domestic Product) numbers.

Output growth has been much less impressive. Over the four quarters ending this spring, real GDP is now estimated to have increased only 1-1/4 percent.

So we are left noting this.

Output per hour increased only 1-1/4 percent per year on average from 2006 to 2015, compared with its long-run average of 2-1/2 percent from 1949 to 2005.

Indeed he goes further.

A 1-1/4 percentage point slowdown in productivity growth is a massive change, one that, if it were to persist, would have wide-ranging consequences for employment, wage growth, and economic policy more broadly. For example, the frustratingly slow pace of real wage gains seen during the recent expansion likely partly reflects the slow growth in productivity

Some might think that a nine-year period is a sign of something persisting as it is only a year short of being another lost decade. For that not to happen now there would have to be quite a change.

Most recently, business-sector productivity is reported to have declined for the past three quarters, its worst performance since 1979.


This week will increasingly focus on US Federal Reserve policy as we approach the annual Jackson Hole symposium where more than a few policy changes have been announced. We will see both sides of the debate jostling for attention but Vice-Chair Fischer has other problems in addition to the ones I have mentioned so far. For example why did our “optimist” not join Esther George in voting for an interest-rate rise at the last meeting? Also why does our “optimist” feel the need to mention this.

that the U.S. economy could find itself having to contend at some point with negative interest rates–something that the Fed has no plans to introduce;

Surely in his world of rising interest-rates this is of no concern at all. Let us leave him singing along with Eminem and Dido.

The morning rain clouds up my window and I can’t see at all
And even if I could it’ll all be gray, but your picture on my wall
It reminds me, that it’s not so bad, it’s not so bad

Bank of England Brainwashing

I was concerned to note that there was clear evidence of this yesterday as West Han United fans sang along with the Bank of England theme song so enthusiastically! 🙂

The Olympics

I am sad to see it end but there are dangers in bringing it into everything as Gideon Rachman of the Financial Times has illustrated today.

Obscure fact: Katarina Johnson-Thompson high jump of 5.98 in heptathlon would have won gold medal in individual women’s high jump

Actually she would have won the pole vault as well and would have saved on the pole! Even if we correct to 1.98 we have the problem that Thiam of Belgium also jumped it and is recorded as number one in the heptathlon high jump.





18 thoughts on “What will the US Federal Reserve do next?

  1. The jobs report is, in my view, a joke. From what I can see it is little more than a statistical extrapolation swamped by a seasonal adjustment; a virtually meaningless metric.

    If you look at all the other surveys/ statistics they paint a very mixed picture indeed and one that indicates a severe slowdown/ recession rather than the sunny uplands of Fischerland.

    Interest rate rises? The election is too close and Trump has said he will sack Yellen – somehow I don’t think so.

    The Fed are clueless, in a box, have been for years and there is no painless way out. In my view all they are doing is waiting for the Black Swan to come along to provide a cover for their many and egregious failures.

    • BobJ, I am not sure the US unemployment rates are as bad as all that. However, one bizarre aspect of the Consumer Population Survey from which they are drawn is described below:
      Households interviewed for the CPS are in sample over a period of 12 months, but they are in sample for four months, out of sample for the next four, then in sample for another four months, so they are only actually in sample for eight months. The unemployment rate for the people being interviewed for the eighth time is ALWAYS substantially lower than for the people being interviewed for the first time. The explanation seems to be that respondents quickly realize that if you report yourself as umemployed you have to answer fairly onerous questions about job search that can be avoided if you don’t say you are unemployed. The problem has been aggravated since 1994 when the CPS was redesigned and the job search questions were expanded. The paper says the same problem exists for the UK Labor Force Survey, but isn’t as bad. (UK respondents aren’t so lazy? Job search questions aren’t so onerous?)

      • Andrew

        Thanks for that.My main point was more directed towards the seasonal adjustment. I believe that in a recent month the SA was four times the net change! Now I appreciate that this in itself does not render the SA wrong but the SA is a statistical calculation and with such large adjustments the net numbers must be taken with a fairly large pinch of salt as no one knows what the actual SA is.

        • BobJ, I probably have more respect for the seasonal adjusted estimates than you do, but I agree that the seasonal adjustment has a big impact and it is sometimes even the sign of the change they show is questionable, let alone the rate of change, especially in a leap year like this one. I guess the alternative would be to look at just the 12-month rates of change for employment, which is essentially what the US Fed does with the price index data. But that kind of a measure is sensitive to big changes 12 months ago dropping out of the annual rate of change, that really have nothing to do with what is happening in recent months. StatCan used to publish an annualized three-month rate of change for the seasonally adjusted CPI. I’m not sure why, as I thought it provided a more up-to-date measure of inflation than the 12-month rate of change, although it was also more volatile, and as you say, the seasonal adjustment can’t always be trusted.

  2. I think they’ll raise 1/4% this month or next, and I think this because:
    1) US Fed is not quite the captive of the banks that the BoE is, and won’t act solely for their benefit.
    2) I don’t think that level of rise can’t be dealt with, without too many real problems for the US economy, and unlike BoE/ECB the Fed really does want to normalise, as far as possible, in order to give itself room at the next downturn.

    Fed may find that it dare not raise, but it’s itching to.

    • Hi therrawbuzzin

      I agree that some of the FOMC want to raise again and if so it will be logical to keep as clear of the election as they can. Especially this election! However if they were going to give a series of raises then we should have seen more already and of course they have cried wolf plenty of times.

      As to the banks the argument is that rises in the Fed Funds rate help them here and of course help longer-term products such as pensions and insurance.

      • I’m not sure that the Fed has cried, “Wolf!” the way the BoE has; remember there was intent to deceive in the story.
        I think it’s going to raise as quickly as it dares; juxtapose with the BoE, which will raise as slowly as it dares.
        A crucial difference which, because of the state of the World economy has not yet become palpable, but which I believe may, over the coming year/18 months.

  3. Great blog as always, Shaun.
    In defence of Stan Fischer, the PCEPI has been the US Fed’s target inflation indicator from the beginning, although in the FOMC minutes the CPI inflation rate is also referenced. Of course, they are both highly dysfunctional indicators that have the same rental equivalence approach to owner-occupied housing that one finds in the CPIH that the UK power elite seems to be trying to force down the throats of the British public. The US does have its own HICP series but not, alas, its own OOHPI series. In July the annual inflation rate of the US HICP for the total population was actually -0.01%, down from 0.24% in June. However, the core inflation rate (HICP less food and energy) was much higher, 1.68%, down from 1.77% in June. Although there is no OOHPI for the US, for certain a US HICP that incorporated one would show a higher core inflation rate, close to the two percent target. The 20-city composite Case-Shiller home price index showed an annual inflation rate of 5.2% in May, down from 5.4% in April, with Zillow Real Estate Research backcasting 5.0% for June.
    I think people on the FOMC who are serious inflation targeters would face a difficult choice. Properly measured the US has the highest core inflation of any G-7 country except for Canada. It may still be below the two percent rate, but it was a mistake for the US Fed to set the rate that high anyway and probably some members implicitly or explicitly target something lower. On the other hand, it seems that the inflation rate right now is declining rather than rising, and it would be hard to say, for me if not for them, whether this is a bit of a blip, or part of a trend. I would be interested in knowing where you think US inflation is likely to be 18 or 24 months from now. Like Stanley Fischer, do you believe it will pick up?

    • Hi Andrew

      Thats a good question so let me give it a go. In recent times lower commodity prices have reduced US inflation and a stronger US Dollar will have added to this, although the currency is a smaller impact than the UK or Canada because so many prices are in US Dollars. There are signs of both ending which may change for the latter but goods inflation will tend to rise if commodity prices remain unchanged.

      Inflation in services is even stronger than in the UK as the CPI breakdown shows. I know that PCE is the target but the CPI breakdown helps. For example services (excluding energy) are rising at an annual rate of 3.1% being pulled higher by medical care at 4.1%.

      I am not a fan of using rents but the US shelter index at 3.3% is at least somewhere near to house price inflation and is in the CPI!

      So the trend is for higher inflation and it will take more goods/commodity disinflation to hold it back. As for 18/24 months ahead though some humility is required as in these times any thoughtful person realises that there is a lot of uncertainty.

  4. Hi Shaun – “What will the US Federal Reserve do next?”

    Easy, raise rates before year end regardless of election background noise.

    Why? I posted on here last year that the US faced a big problem re a potential down swing in the 3 – 5 year Kitchin inventory cycle, with the last bottom having occurred in 2012 leaving the US odds on for another downswing in 2015/2016 whilst the last 7 – 11 year fixed investment Juglar cycle downswing began in 2008 leaving the next one due 2015 – – 2019. I said here last year that if both coincided in 2016 the US had big problems.

    Thankfully, the worst of the Kitchin downturn appears to be over although it is still continuing but I don’t expect it to be as big a drag on US GDP from here on. Meanwhile US investment in the form of the Juglar cycle appears to be about to pick up as industrial output of investment equipment has gone up in the last few months and the two appear closely correlated – https://az768132.vo.msecnd.net/images/7765_2016_08_18_12_16_02_453.gif

    Even the US drilling/mining investment cycle appears to be turning – https://az768132.vo.msecnd.net/images/7766_2016_08_18_12_16_02_533.gif

    The levelling off appears to coincide with the increase in oil price which I only expect to increase from here along with most other commodities thereby encouraging further drilling/mining.

    Meanwhile narrow money growth shot up last year.

    When all this is viewed in the round – the Kitchin cycle losing it’s power as a drag on the US economy, US investment about to pick up, narrow money increasing last year and steadily rising real wages this points to a growth spurt for the US in the second half of this year and potential inflation boost in 18 – 24 months time.

    Yellen is no fool (unlike the UK and EU shower) and will realise that she has to act in the next few months if she is to offset an inflationary pulse in 18 – 24 months and create wiggle room for EFFECTIVE monetary policy to provide a true stimulus in the future when the next real down swing arrives.

    She will no doubt have US exporters screaming in her ear for rate cuts, so she may do a fudge making a very small hike between 5 – 25 basis points before year end but the next move will definitely be upwards before year end.

    • Hi Noo2

      Perhaps with the nudge higher in the oil price the drain on industrial production and manufacturing from that sector will fade and go away. Mining was up 0.7% MOM in the latest release albeit still 10.2% lower annually. As to inflation I agree as I have just replied to Andrew. Services inflation is already present and once the goods/commodity disinflation fades the picture could change quite quickly.

      But the truth remains that they should have acted more than once already.

      • Not sure they should have acted already.

        Certainly I was unsure until the latest US investment numbers came in but I could see the US would do OK this year even last year whilst the “experts” predicted great growth for the US which I thought they would be disappointed by in the first half due to the investment cycles, but thought there was a chance of a strong surge in the second half dependent upon developments in the investment cycle. The uptick in investment has just been confirmed imo so now certainty arrives about the picture for the rest of this year and 1st quarter next year and certainty should be accompanied by action, although sometimes the “action” is to do nothing.

        I think they made a mistake saying how many hikes there would be this year although it had the caveat hikes would be data dependent. This is a problem of “Forward Guidance” the IMF is pressuring every one to do. All CB’ers should stop trying to be rock stars and retreat back into the shadows.

    • Don’t believe with their debt approaching $20 trillion that they will ever raise rates they cannot afford to.
      significant inflation or currency reset are only options,just like the Roman Empire over extended spending on a military machine they cannot afford will be their downfall

      • US deficit is quite good – 2.5% in 2015 so presumably not much extra future projected borrowing (circa 2% – 3% pa of GDP) along with 2% – 3% annual GDP growth (again my prediction) making an ongoing deficit at higher rates affordable whilst the existing $20 trillion is already locked in at lower rates.

        I’m not condoning further borrowing, simply saying it’s affordable even at higher rates at the moment. Let’s wait and see what the picture is by 31st December this year. I’ve made my prediction and I stand by it.

  5. In answer to the question they will kick the can down the road until the system buckles under the $200 trillion dollar debt mountain.
    The complete refusal to contemplate that the capitalist economic system that now exists is no more sustainable than the East European communist model.
    It will be interesting to see how much longer this system can survive,these things always last much longer than you think possible,but when the dam bursts the end will come quickly.
    If they don’t start a war first.

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